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The New Zealand Tax Podcast – Inland Revenue cranks up the attention on potential personal services income diversion – a harbinger of things to come?

Public Policy / analysis
The New Zealand Tax Podcast – Inland Revenue cranks up the attention on potential personal services income diversion – a harbinger of things to come?
[updated]
Nicola Willis inbox
Nicola Willis inbox. Source: 123rf.com


The Coalition Government is not proposing to reduce the top rate of income tax from 39% in the near future. It’s therefore probably no coincidence Inland Revenue announced it has started contacting taxpayers it has already identified who appear to be “diverting their income and benefiting from their different tax rate". Inland Revenue has suggested to tax agents to contact it if they think their clients might be affected and has actually given a specific e-mail address for tax agents to do so.

Prior to when the tax rate was increased to 39% in 2021, Inland Revenue released a Revenue Alert RA  21/01 on diverting personal services income. This Revenue Alert did was to pick up what had happened the previous time we had had a 39% tax rate and the famous, or infamous, depending on your point of view, Penny Hooper decisions. Those cases involved two surgeons who each provided their personal services through a company which was in turn owned by a family trust. Although they were each paid a salary, the salaries were not considered commercially realistic, and the Supreme Court ruled the arrangements represented tax avoidance.

The structures used in Penny Hooper are still commonly used today and with the big rate differential between the company tax rate of 28% and the top personal tax rate of 39% there is obviously a quite a heavy incentive to adopt structures to minimise the impact of tax.

Inland Revenue has been looking at these types of structures for some time. Last year it put out some proposals for “countering” abuse which received a fair bit of pushback when it proposed expanding the ambit of the so-called 80% one supplier rule. The effect of this expansion would have meant that a lot of smaller professional services firms would have been caught with more income subject to the individual personal tax rate.

Inland Revenue backed off on those proposals, however judging by what has been said by the new Minister of Finance Nicola Willis about the state of the Government's books combined with the fact that National’s proposed foreign buyer’s tax isn't happening means that the funding of National’s proposed tax relief package is rather tight to put it mildly. Against this backdrop I would not be at all surprised to see Inland Revenue reactivate those proposals from last year and push them forward again

I also expect that the increase in the trustee rate tax rate to 39% from 1 April which was included in a bill of the previous government, and which has just been reintroduced, will go through. It would be consistent to do so when considered as a base protection measure to ensure the integrity of the top personal tax rate of 39% is maintained. Whether there will be some form of de minimis exemption we will have to wait and see.

Tax deductibility when letting a room to a flatmate

Moving on Inland Revenue has also released this week an interesting Question We've Been Asked which will be relevant to a number of people. QBWA 23/08 explains when a person can claim deductions for expenditure occurred in deriving rental income when that person rents a room in their home to a flatmate.

The amount of expenditure which will be deductible will be determined by apportioning between the private use portion of living in the house and the income earning proportion.  Basically, you can apportion based on the relative proportions of physical space: if 20% of the house is being rented therefore 20% of the associated expenditure would be deductible.

The QWBA also covers off the application of other rules. For example, the interest limitation rules which we have been discussing quite frequently recently, these do not apply if the land is used predominantly for the person’s main home.

Similarly, the residential ring-fencing rule will also not apply if more than 50% of the land is used for most of the income year by the person as their main home. In theory if a homeowner had one flatmate and somehow it turns out there was a rental loss, possibly because of high interest payments, such a loss could offset against the home-owner’s other income.

Finally, the complex mixed-use asset rules shouldn’t apply either, because the house is unlikely to be left vacant for the required period of at least 63 days in a year. Even if the mixed-use asset criteria are satisfied the QWBA thinks the exclusion for long term rental property is likely to apply.

The QWBA also notes that in general the fact the person rents out a room in in their home to a flat mate while living in it should not stop the home being the person's main home. Overall, this is an interesting QWBA even if only applicable in very specific circumstances. I think given the way interest rates have risen and the large mortgages some people have had to take on to get into the housing market makes it of more relevance appears at first sight.

WorkRide FBT exemption

Another bit of good news this week is the release of a Product Ruling in relation to provision of self-powered or low-powered commuting vehicles to employees of WorkRide’s customers.

Under the WorkRide scheme it enters into agreements with employers under which the employees of WorkRide’s customers agree to a temporary reduction in salary in return for a temporary lease of an electric bike/electric scooter and the opportunity to own the bike/scooter at the end of the lease period.

This associated Product Ruling BR Prd 23/06 came into force on 1st December.

Under the ruling so long as the limits of the cost of the equipment being provided to an employee are not exceeded, the employer is not liable for Fringe Benefit Tax (FBT) on the value of the bike/scooter provided. The cost limit is to be set by way of regulation. So far the relevant regulation has not been issued, but is expected shortly. The employer can claim the GST charged on the leasing of the equipment to it by WorkRide. The amount of the salary sacrifice agreed between the employer and the participating employee cannot exceed the amount of the service fee charged by WorkRide. The amount of salary sacrifice does represent a taxable supply for GST purposes.

This FBT exemption was a late amendment to the Taxation (Annual Rates for 2022–23, Platform Economy, and Remedial Matters) Act 2023 passed in March.

It will be interesting to see how many people take up the exemption which certainly should be attractive to those working in inner city areas.

$1.4 billion of interest deductions claimed for 2021-22 tax year

Finally, this week, coming back to interest deductions, tax guru and former podcast guest John Cantin posted on LinkedIn earlier this week an Inland Revenue response to an OIA request he had made regarding the amount of interest deductions claimed by residential property investors in the 2021-22 tax year together with the amount of rental losses “ring-fenced”.

In summary,140,660 taxpayers claimed interest deductions totalling just over $1.4 billion. 47,490 of these had $663.9 million of rental losses ring fenced after deducting 563.9 million. Therefore 93,170 taxpayers claimed interest deductions totalling $845.6 million, which were allowed in in full. This means about a third of all taxpayers (33.7%) had their interest deduction effectively limited and this amounted to about 40% of the total interest deductions.

We don’t know the exact fiscal effect, that’s dependent on each taxpayer’s marginal tax rate. Assuming an average 20% rate, the cost would be $169 million and on a 33% tax rate $279 million per annum.

These figures are for the first tax year in which the restrictions kicked in, which was 25% non-deductible from 1st October 2021. The first full year of restrictions is for the year ended 31 March 2023. But the data for that year won't be available until after March next year when the filing period for 2023 tax returns is over. You can still see there's quite some significant numbers here around the impact of restricting interest deductions and therefore the cost of removing those restrictions.  

Incidentally on this I'd be very interested to see what happens going forward for investors buying properties which don't qualify as new builds. At present such investors aren’t to claim interest deductions and that was a deliberate policy decision by the Labour government.  Could the new Coalition Government change that rule to allow interest deductions subject to the interest limitation rules for the relevant period. We shall see, and as always, we will bring that news when and if it happens.

And on that note, that's all for this week. 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 and please send me your feedback and tell your friends and clients. Until next time, kia pai to rā. Have a great day.

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19 Comments

NZ Superannuation costs the country $18 billion a year.

If a government really wanted to raise revenue it would reintroduce the superannuation surcharge, or surtax, abolished in 1998. That would ensure that NZ Super, while remaining (almost) universal, would go to those who need it, rather than as a nice little freebie to those over-65s already rolling in dough.

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"...rather than as a nice little freebie to those over-65s already rolling in dough."

In 2000 only 5% of people receiving nz super were still working, now ~ 5x that. "rolling in dough" - not.

As you know, the surtax will not be reintroduced, Winston killed it last time.

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I think he's talking about the 75% that don't need to work. Or the smaller group again that probably hasn't needed to work decades before they retired 

Then again what you're saying has merit to, even if there was a change to the universality of super, there's also a call that more recipients need more money than they're currently getting. So likely a zero sum game.

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Keep it simple. To make it cheaper start at a later age and pay less.

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Not a great sales pitch for the kiddies though. Pay more taxes, get less stuff.

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The pitch should be 'pay your taxes and get 12 years pension (on average) as a reward'. Not retire at 65 and live as long as our younger working taxpayers can afford your pension.

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Well, we have the latter, a product of an era when people lived shorter lives, and we had the birth rate to sustain it. The way changes work, you'll get people paying for the status quo, who won't get the same benefit themselves. Kinda hard to spin that positively.

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Ditch super, phase in KiwiSaver over a 30 year programme.  At 30 years National super gone.

KiwiSaver would have to be universal and high contributions.  If you don't think so about those rates, you are believing in the tooth ferry still.

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That's still the same scenario, maybe even worse. A 30 year old will spend 30 years paying taxes for current retirees, whilst also having to pay for their own retirement in advance - paying for their own retirement, and someone else's.

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I think a surcharge of 10-15% of every dollar you earn over around $20k/year until your benefit reduces to 0 would be a reasonable thing to bring in, and save a lot of money each year.

It would be similar to student loan repayments, so shouldn't be too hard for IRD to implement.

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Once again, Terry - so informative.  Great summaries and explanations.

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whats the point of having a tax deductibility on flatmates rent, I recall some rules which apply if its less than a certain amount and only one flatmate, that there is no deductibility and there is no tax, as its assumed cost and income will be similar

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They used to be called "boarders".

Currently up to $222/wk/boarder up to 4 boarders

https://www.ird.govt.nz/property/renting-out-residential-property/resid…

 

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No. Boarders and Flat Mates are treated very differently, or can be treated the same.

The $222/wk figure is for when the person providing board, which includes things like meals at set times with the family and/or other boarders, and finds it too hard to account for all expenses. If the $222 / week amount isn't used then boarders and flat mates get treated much the same.

This QWBA (Questions We've Been Asked) explains the treatment for flat mates.

https://www.taxtechnical.ird.govt.nz/-/media/project/ir/tt/pdfs/questio…

Take care how you decide to declare either boarder or flat mate income - they are treated differently.

As a friend of mine with mortgage free house now knows - the IRD can go back quite a way (10 years?) if they think you've been doing it wrong, and penalties will apply in most situations.

If doubt - talk to a tax specialist. A 30 minute chat will avoid a world of pain.

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Was this an undeclared flatmate income situation. Or a deduction of expenses problem 

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The former. They were unaware of the difference between boarder and flatmate. They were given a "please explain" about a separate issue.

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I can't see this dragging in much revenue, for a start off a lot of people with flatmates, only do that to help with the mortgage, and with the insurance and rates these days, plus repairs and maintenance , as the mortgage gets under control, these people often live alone.

IRD  might have a better return on effort chasing all the air bnb s, there are so many granny flats, even rooms in houses, which are not declared.

we are missing tax  in NZ, from overseas based tour companies employing NZ guides, there are tons of companies, some sending out 4 tours a week, where the company is based in the USA, or somewhere else, and the guides are paid into their bank account, some who have it paid into overseas bank accounts, with no tax deducted, no GST paid, no ACC levies paid, no tips declared.  look up these companies from the USA,  VBT, Overseas Adventure travel, Gate 1 travel, Backroads, This is the tip of the iceberg.

Commisions by tour operators to guides are still paid in cash by an envelope,  check out helicopter companies, jet boat, rafting, etc etc, There are moves to pay these into bank accounts, but that doest  collect tax, just makes it easier for the helicopter company to account for the payment.

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The 80% one supplier rule really needs revisiting.

So many of my ex-colleagues are pretending they are sole traders (contractors) but have just a single customer that they've been working for, for many years. Basically they're employees.

But they use their status, not so much to minimise income tax differentials although it does, but to get tax subsidies by buying stuff and paying for stuff through their "business". Most is small change but its a subsidy not available to actual employees doing the same jobs. In some cases though, its big change. One pays their mum as a receptionist / admin person but they do all of this and mum has no real idea she's employed.

I wonder where the IRD is going to use the new money they've been given ... 

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how would they know there was an 80% supplier ,in the mix, is it 80% by value, or 80% by number of customers, ?  

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