New Zealand Tax Reforms on the Horizon?

– What will come out of the Governments Tax Working Group?

 Introduction

The new Labour led coalition Government has announced the composition of its Tax Working Group[1] to look at the structure, fairness and balance of New Zealand’s tax system. The Government expects to receive final recommendations from this TWG by February 2019 (an optimistic timeframe), with any substantial new tax law to be timed for the 2021 tax year (following the 2020 election cycle). The Government has established the terms of reference, and through the outcomes of this Tax Working Group (‘TWG’) will receive some political charter to introduce tax reforms, or not.

In this article, I address:-

  • The terms of reference, and what areas of NZ tax law will attract attention;
  • Has the Government got it right with the composition of this TWG?;
  • Drawing from prior tax working groups
  • What can we expect? Substantive overhaul, or fine tuning?

NZ’s tax engine is like a plug-in hybrid. We can expect some remedial changes and improvements, but the well spec’d car will remain, albeit in the shape of the next generative fully electric model.

Terms of Reference for the Tax Working Group

The Government’s terms of reference for this TWG[2] are looking for improvements to what it recognises as a fundamentally sound tax system, rather than a comprehensive review, as has been undertaken by previous TWG’s[3]. Its focus is on perceived inequities and current failings, with a ready eye on future-proofing the tax system given the likely economic environment over the next decade.

Minister’s have stated: This working group is not about increasing income tax or the rate of GST, but rather introducing more fairness across all taxpayers.

Targeted areas of the tax system under this review include:

  • The economic environment that will apply over the next 5-10 years, taking into account demographic change, and the impact of changes in technology and employment practices, and how these are driving different business models;
  • Whether a system of taxing capital gains or land (not applying to the family home or the land under it), or other housing tax measures, would improve the tax system;
  • Whether a progressive company tax (with a lower rate for small companies) would improve the tax system and the business environment; and
  • What role the taxation system can play in delivering positive environmental and ecological outcomes, especially over the longer term.

Housing affordability and property speculators is a notable social issue of this Government. In the absence of a specific and comprehensive capital gains tax regime, pressure is mounting on measures that will target and tax property speculators and developers who have been identified as under-taxed, while to blame for skyrocketing house prices.

The previous National Government responded to mounting public concerns in 2015 by introducing a new two-year brightline test to tax all gains from sales of residential houses (except vendors of family houses). This new land sale rule supplements existing rules that are intention based, and subjective. In the build up to the 2017 election, Labour stated its intention to extend the brightline test from two years, to five years.

 Capital Gains Tax is the proverbial ‘elephant in the room’, given that NZ has no specific and comprehensive CGT regime.  Notwithstanding that Labour’s electorate campaigning over the previous two elections included detailed policy on introducing a comprehensive CGT, this current Labour Government would not be drawn on its intentions here, preferring instead a ‘wait-and-see’ approach to outcomes from its planned TWG.

Of interest here is that OECD Economic Surveys have historically identified the absence of a comprehensive CGT as being an inequitable gap in the NZ tax system and encouraged its introduction. NZ is one of the few OECD countries[4] that does not possess a comprehensive CGT.

The McLeod Tax Review in 2001 did not recommend introducing a CGT. The VUW TWG in 2009 noted the absence of taxation on capital as a major hole in our tax base, yet the majority of its members had significant concerns over the practical challenges that a comprehensive CGT would entail, and did not recommend introducing such a regime.

Treasury sees merit in a general CGT. On the other hand, Inland Revenue policy officials harbour some reluctance to introduce a comprehensive CGT[5].

The Labour Government may well be satisfied with measures to strengthen the taxation of speculative land sale gains, without taking the ‘big step’ of introducing a general CGT (something that successive Governments have resisted). They have specifically excluded from the TWG any taxes on the family home, and any inheritance tax.

Increases in any tax rates, or the rate of GST are off the table for the TWG under the Government’s terms of reference. As a corollary, and looking out at the international economic environment, we face huge competition from falling corporate tax rates of our major trading partners, including President Trump’s latest US tax reforms. While many inter-playing factors influence country headline tax rates, the following Table is “indicative” of where NZ compares internationally: –

Country Corporate Rate – Now Corporate Rate – Future
New Zealand 28% 28%
Australia 30% 25% (decreases over 8 years)
United Kingdom 19% 19%
USA 35% (40% with State Tax) 21% (26% with State Tax)
Canada 26.5% (incl. State Taxes) 26.5% (Incl. State Taxes)
Global Average 24.25% Likely Falling
OECD Average 24% Likely Falling
Euro Average 19.5% Likely Falling

As a capital importer, Treasury is very mindful that NZ remain a country that is attractive for foreign investment, and the above Table with its declining tax rate trends will test the TWG considerations. The terms of reference for this TWG do raise whether a lower rate of tax for small companies may be an improvement. On this, many countries do have concessional corporate taxation for SMEs, and I would expect similar system design to feature heavily with this TWG.

International taxation and foreign investment has featured heavily with NZ tax reforms of late and the terms of reference expressly state that the focus of the TWG should not be on technical matters already subject to the current Tax Policy Work Programme with this TWG. Of note here are changes enacted to reform at the border non-resident withholding taxes (NRWT). Also, and more substantively, are extensive measures under current legislative reform[6] under the BEPS agenda (Base Erosion and Profit Shifting as embodied in the OECD’s global project). These measures strengthen NZ rules to prevent NZ’s tax base being eroded by artificial structures, and introduce tougher transfer pricing measures to capture income sourced from NZ.

In recognising the importance of foreign direct investment to the country’s GDP per capita, the 2001 McLeod Tax Review raised options for reducing the tax impost on foreign investment, however this approach pre-dated the global BEPS campaign on fairer international taxation of multinational companies.  Given the current BEPS agenda, and media/public sentiment against foreign investor tax breaks, similar considerations would represent a very hard road and be politically unpopular.

The other side of international tax involves measures to assist NZ business investing offshore through changes in how NZ resident individuals and business are taxed at home (in NZ) on income earned abroad. Again, a number of the 2001 McLeod Tax Review recommended improvements here were adopted by Government (most notably the active vs passive CFC income distinction and exemptions). Perhaps one area that may attract attention is the taxation (and credit method) vs exemption method for NZ business conducted offshore via a branch (instead of a company that could be exempt under the active CFC rules).

Other matters include concerns with distortions in effective marginal tax rates (EMTRs) as a result of abating social assistance (especially through Working for Families). High EMTRs will distort decisions, reducing incentives to work and upskill.

Also, is the GST system, and whether any case is made for introducing exemptions to either assist families, or, to influence behaviours (eg., sugar taxes vs healthy eating with fruit and vegetables). Prior TWG’s have justifiably been opposed to interfering with our ‘across the board’ GST system, and this should remain as the status quo.

What of this Tax Working Group?

The composition of this Labour Coalition Government’s TWG is very solid. In appointing Sir Michael Cullen to the Chair, we have a hugely experienced individual[7] under whom the 2001 McLeod Tax Review reported. Members of the TWG comprise some highly talented and deeply experienced individuals. Professor Craig Elliffe University of Auckland), Geof Nightingale (PwC), Robin Oliver (former Deputy Commissioner IRD), Michelle Redington (Air NZ) and Joanne Hodge (formerly Bell Gully) all have deep taxation and industry expertise, yet they bring differing representative perspectives to the table[8]. Added to this is a good mix of business, Maori sector, and union representation.

The only worry perhaps is the size of this TWG with 11 members, which will certainly test Sir Michael Cullen’s chairmanship! I say this bearing in mind the smaller numbered group of the 2001 McLeod Tax Review, and the quality and efficiency of its output, compared to the 13 strong VUW TWG that struggled reaching consensus on a range of matters.

The Government sought a TWG with diversity, and expertise, and they earn a pass mark for this group. As with all things, the proof will be in the actual outcomes that this TWG concludes on, but the people framework looks positive.

Drawing from Prior Tax Working Groups

NZ’s tax system has been reviewed regularly by successive TWG’s.

The Task Force on Tax Reform in 1982, chaired by Malcolm McCaw, involved a comprehensive and systematic review of our then deeply troubled tax system. Reforms since the McCaw Task Force, saw a necessary change from narrow tax bases with high rates of tax, to broad bases taxed at lower rates. GST was introduced, and international tax regimes overhauled, along with the removal of many tax preferences and exemptions. Company tax changed with the inter-linking of personal investor taxation via the dividend imputation regime (in 1985).

Nearly twenty years later, under the then Labour Government, The Tax Review – 2001, led by Rob McLeod, comprising a tight group[9] of tax experts and economists, adopted a comprehensive and deeply analytical approach. This review concluded that NZ’s tax architecture was in sound shape, and radical restructuring was not required. The broad base, low rates approach developed over the last twenty years is sound and should be continued. New Zealand reforms should focus on incremental improvements. That said, the McLeod Review explored some radical tax issues that caused some public outcry, albeit these have remained within ongoing tax policy debates.

A ‘collective’ TWG was formed in 2009 – The Victoria University of Wellington Tax Working Group[10], chaired by Bob Buckle. This was a coordinated effort initiated by VUW’s Centre for Accounting Governance and Taxation Research, in conjunction with Treasury and Inland Revenue. The review was a limited scope one (with limited resourcing) focusing on policy options required to address the medium-term direction of the tax system, and designed to stimulate major issues that should be at the forefront of Government tax system consideration. In a departure from the McLeod Tax Review, the VUW TWG conclusions were that NZ’s tax system was flawed. New Zealand’s tax system is not working effectively and reform is necessary if the country is to have a fair tax system that minimises the costs of raising taxes, reduces barriers to productivity and growth and positions it well for future challenges. The current system is incoherent, unfair, lacks integrity, unduly discourages work participation and biases investment decisions.

Notwithstanding this harsh and poor ‘health report’, the VUW TWG did endorse the broad-base, low-rates option, stating that this should continue to be an underlying framework for the NZ tax system. Also, and in the same vein as the McLeod Review, the VUW TWG endorsed the Government’s goal of aligning the tax rates of personal, trustee and corporate taxpayers.

However, its proposals commonly struck differences and lacked full consensus. As such, there is some basis that the stated conclusions of the VUW TWG were somewhat “over-amplified”.

Beyond these official tax reviews, there have been very numerous discussion documents from Government, Treasury and Inland Revenue on a range of specific tax reforms to the NZ tax system.

The point here is that there is a wealth of existing analysis on the NZ tax system, much of which remains highly relevant today. The McLeod Tax review in 2001 remains as a blueprint authority, and international endorsements of the compelling fundamentals of our tax system suggest that a major overhaul is uncalled for. To its credit, the Labour Government recognise this in their terms of reference.

Conclusion

Following from above, this Labour Government TWG is about ‘improvements’ rather than any overhaul of NZs fundamentally ‘sound’ tax system. In the context of a well running motor vehicle, progressive tax reforms over the years have moved us from an internal combustion engine to a plug-in-hybrid, and this TWG will likely yield the next generative electric motorised tax system. The same well spec’d car will have some design faults remedied and will negotiate the roads ahead more efficiently, and possibly, with more New Zealanders buy-in to the improved model.

AUTHOR:

Andy Archer

Acumen Limited

www.acumen.kiwi.nz

31 January 2018

[1] See the media statement dated 20 December 2017 from the Ministers of Finance (Hon Grant Robertson) and of Revenue (Hon Stuart Nash) taxpolicy.ird.govt.nz/news/2017-12-20-tax-working-group-members-announced

[2] https://www.beehive.govt.nz/…/towards-fairer-tax-system-tax-working-group-terms-r…

[3] Refer to coverage of previous TWG’s in section below.

[4] Some 30 OECD countries tax capital gains, including NZ’s major trading partners USA, UK, Canada, Australia.

[5]See the IRD’s paper to the VUW TWG https://www.victoria.ac.nz/sacl/centres…/3-taxation-of-capital-gains-ird_treasury.pdf

[6] https://www.parliament.nz/…/taxation-neutralising-base-erosion-and-profit-shifting

[7] Sir Michael Cullen was the Finance Minister from 1999 to 2008. The author is critical of some of the tax measures under his ministry (notably the mis-alignment of tax rates with the increase in top personal rate from 33% to 39% which fuelled a growth of taxpayer income sheltering), however the lessons will have been learned.

[8] Of interest and relevance is that Geof Nightingale was a member of the 2009 VUW TWG, and Robin Oliver attended as the then Deputy Commissioner of IRD.

[9] This group comprised just 5 members, with added input from an international independent expert.

[10] A group of 13 members were drawn from expert tax practitioners, academics, business people, and government officials, who contributed research papers (on a voluntary basis), and undertook open forum discussions. This TWG worked under the backdrop to the Global Financial Crisis which meant that acute fiscal constraints over-shadowed and challenged tax policy reforms.

%d bloggers like this: