Terry Baucher talks to Nigel Jemson about a Trusted Taxpayer Regime as a possible alternative tax regime for small businesses

The Tax Policy Charitable Trust aims to promote broader tax thinking and positive tax policy.  As part of this it runs a biannual scholarship competition open to young professionals working in New Zealand. I'm joined today by Nigel Jemson, the winner of the Tax Policy Scholarship Competition for 2019. Nigel has been working in tax for seven years and is currently the group tax manager at Spark New Zealand. Morena Nigel, welcome to the podcast.

Nigel Jemson
Good morning, Terry. Great to be here.

Terry Baucher
Thank you. Now, you won the competition with a proposal for a Trusted Taxpayer Regime. What are the key components of this regime?

Nigel Jemson
So when designing this proposal, I was trying to design something that would give benefits to both small business and Inland Revenue.  From the IRD perspective they have a problem of administrative costs and being able to effectively scrutinise taxpayer compliance across a wide population.  That's quite difficult to achieve in a cost-effective manner. So in order to enhance IRD’s ability to do this, I've proposed under the Trusted Taxpayer Regime, IRD would gain access to tax payers financial information via a real time link to the tax payers accounting software. That would save IRD the administrative costs of having to request access to that information and they can order that in real time.

TB
They can access that information anyway in the first place by demanding it under section 17 of the Tax Administration Act 1994.  

Nigel Jemson
Yes, I think that's just means I can just get access to that data in real time and potentially run data analytics and be able to audit taxpayer data faster to scrutinise taxpayer compliance more effectively.

Fortunately for small business, there is a benefit for them as well. In return for giving up this power out and their revenue and to encourage the small business to be a trusted taxpayer that get a 10 per cent tax discount on their income tax payments throughout the year. The second benefit under this proposal would be removal of the end-of-year tax filing obligation. This would be replaced by a less onerous quarterly tax statement, which would be a simplified sort of quarterly tax assessment which would replace the current provisional tax obligations.

TB
That's excellent.  I'm fascinated that you're currently working at Spark, one of New Zealand's largest companies, yet your proposal is very much targeted at small businesses. It is in an area where you wouldn't normally deal with this day to day So what attracted you to this idea?

Nigel Jemson
Yeah, it's quite ironic, as when I won one manager said, "OK, can your next idea be something that targets large corporate telcos?".

in light of the tax policy scholarship competition’s briefing to propose a significant reform to the tax system, I had to design a proposal that would have a wide ranging impact.  So I designed a proposal that would benefit the vast majority of businesses – the proposal targets businesses (including companies, partnerships and sole traders) with less than $5m turnover which is 97.5% of all businesses according to Stats NZ.

Small businesses in particular, do suffer under higher compliance costs relatively compared to other types of tax payers and larger tax payers. If you think about a sole trader business, for instance, they've got to deal with a number of tax obligations that an employee wouldn't have to deal with: more complicated income tax returns, provisional tax, GST, PAYE etc. And compared to larger businesses, small businesses also have relatively less resources in time to deal with these tax obligations that are imposed on them and they don't have the money to hire a tax professional like me full time. So it made more sense to target a proposal where it could achieve the greatest benefit.

And another criteria for the competition was feasibility of introduction and political acceptance. I think if my proposal had incorporated all businesses it would be harder to justify from a fiscal cost point of view and also might be less likely to gain broad public acceptance because there is a negative perception of large corporates getting tax breaks.

TB
But it doesn't cover all corporates it's across all small businesses and sole traders as well.  Talking it on the politics of it, listeners will know I was a member of the Small Business Council. I 'd have to say that if we had been aware of this proposal, (we had wrapped up our report by the time Nigel Jemson wrote it), we would have taken a very close look at it because it addresses the issues that you raised about compliance costs and the burden for small businesses in that they're expected to do all be all things to all people, but without the resources of a Spark.

So what are the benefits in this proposal for both Inland Revenue and businesses?

Nigel Jemson
So for Inland Revenue the aim was to lower the administrative costs and improve their effectiveness of administering the tax system. So easy access to taxpayers' financial information would reduce the time and effort required to access their information and therefore make it easier to check and enforce compliance. And there could be other flow on benefits as well from having access to such a large data pool, for example they could run analytics over that over that data to try and find potential risk areas.

And due to greater oversight I think as well because trusted tax payers have elected into this regime and know the IRD is watching them, they're more likely to be compliant in their tax affairs. And then IRD can focus more resources comparatively on taxpayers who are not in the regime because they know they're probably less likely to comply.

TB
As part of that you are saying that really this scheme should target businesses where more than 80% of the income is of a basically non-cash basis where it is easily trackable. These businesses, in any case, are probably are working with accounting systems anyway. There is some leeway around that 80% threshold, but it mainly targets non-cash businesses.

Nigel Jemson
Yeah, you have to have 90% of your total receipts being non-cash. And the reason for that is just so there's a data trail so you can actually verify that the receipts that the business is getting. And there would be a number of safety checks in place so that IRD could know that taxpayers weren't trying to hide cash receipts from it. There'd also be some sort of link between the bank account and the accounting software to prevent manipulation of the data.

TB
Your Trusted Taxpayer regime bears some similarity to the existing Accounting Income Method, which I've heard described as a good idea, badly executed. And just as an aside, one of the reasons why the take up of AIM has been is the question of Inland Revenue's concerns about manipulation have put too many prescriptions around its use.  And I think you've managed to sidestep those issues I believe. So, what would you say are the major differences between your proposal and the Accounting Income Method?

Nigel Jemson
Well, my proposal is similar in the respect that you calculate and pay income tax as you go. My proposal has a concept of a quarterly tax statement, which is a kind of simplified mini income tax assessment.  AIM has a statement of activity, which is a similar concept. What I've tried to do is simplify and refine that process so it's less onerous on the small business. Under my proposal, the amount of tax payments would be reduced to four times a year. Under AIM you'd still need to file a tax return at the end of the year, whereas the Trusted Taxpayer Regime removes that requirement.

And I think that's quite a benefit to the taxpayer. Because I don't have to have that end of year wash up, another point in the year when have to think about tax and get a tax agent involved. So that is good, I think. The kicker is my proposal actually provides a decent incentive to join with a 10% tax discount for the taxpayer. I like the idea that if the taxpayer does something which actually lowers Inland Revenue's administrative costs, the small business should get some benefit from that. I think it's quite an attractive proposition. And in this case, I think real time access to taxpayers’ financial information could deliver a real benefit to IRD and it could be compensated in some way. And the final thing I note, it's just that the lower amount of tax payments at four times a year instead of AIM's six payments.

TB
Yeah, it's funny you raise this point because one of the issues whenever small business taxation comes up it is frequently accompanied by a call for a lower tax rate. And you've you've been very specific in rejecting that approach instead of opting for this 10% tax credit. Would you please give us a little bit more behind your reasoning on that?

Nigel Jemson
Sure.  I opted for a tax credit for a couple of reasons. Firstly, a blanket lower tax rate across the board for small business doesn't really mesh with my idea that taxpayers had to do something extra that actually benefits Inland Revenue to get the discount. So, you had to target this in a way that has a credit rather than some sort of special class of taxpayer that has a lower rate. A tax credit just makes it easier to deliver that, whereas a lower tax rate across the board would introduce significantly more complexity.

TB
And just speaking from the discussions I know went on within the Tax Working Group and in the Small Business Council, whenever the idea of a special rate for small businesses came up, it  was rejected out of hand for those reasons that it was too broad. What I find appealing about Nigel's proposal is it's targeted and the fiscal cost is much less. Although you have to go through quite a few number of hoops to qualify for it they're not insurmountable. So that's a good trade-off here, which is why I like it.

A tax credit for corporate taxpayers would also include an imputation credit so that would benefit the final shareholders. If you had a lower tax rate and then the profits are distributed out to the shareholders there's ultimately no benefit because that's going to be taxed at the higher rate of 33%. 

Now, one of the fascinating things about this paper is you actually quote the Journal of Economic Psychology. Who knew that existed? And you talk about tax morale. Now, what do you mean by tax morale and why do you think it's important?

Nigel Jemson
So tax morale is the overall sense in society of whether the tax system is fair ie whether people feel that they have a moral obligation to pay taxes and believe it's the right thing to do, regardless of what sort of enforcement obligations or penalties might apply to them. And I think that's really important. We have a self-assessment system in New Zealand.  IRD to a large extent relies on people to voluntarily comply because they believe it's the right thing to do.

And simply put IRD cannot audit the whole population. They need tax morale to be strong in our society. And I think we do have pretty good tax morale in New Zealand.

My proposal is designed to enhance tax morale further. I think if you introduced an additional IRD access to information without having some quid pro quo for the taxpayer in return, that would probably not go down too well with small business because Big Brother's watching you. So, I think having an actual incentive for small business in the form of a tax discount is designed to encourage them into the regime and boost tax morale.

TB
I mean, this is one of the things I really like about your Trusted Taxpayer Regime is that its name and its approach recognises that small businesses act as unpaid tax collectors and frankly, it's a bit of a sore point at times. And so just about tax morale, you're quite rightly pointed out that if you were to say, "We've got this brilliant idea, you're going to let Inland Revenue have access to everything" and there's no quid pro quo. Well, it would be worse than AIM, which has had a very little take-up with people and people are just not going to buy it. In this case, there is a definite quid pro quo. Many of the businesses that qualify for it would be well along that pathway anyway to integrating their systems with software such as MYOB.

But most importantly, we get called customers a lot by Inland Revenue now. But this is something that actually says, "Well, yes, you are customers, you're helping us. And here's something for making our day a bit easier". So, what prompted you to include this idea of the sort you're talking about, recognising the role of small busineses as tax collectors?

Nigel Jemson
Often from my own personal experience as a tax professional, there are a lot of additional obligations aside from income tax which are imposed on businesses. So, you have GST, PAYE etc. I know a lot of my own time and my own role is spent on non-income tax obligations, so I can only imagine for small business with less resources to deal with that what it would be like. So that's that's another reason why I've proposed an actual cash tax discount with this 10% discount, because there's only so much you can do to simplify the tax system and make it better. Another way of doing that, would be simply by reducing taxpayers’ costs, having less tax to pay.

TB
Currently, for Pay As You Earn if you use a PAYE intermediary you will get a subsidy for that. But incredibly, that's being withdrawn at the same time as the requirement for payday filing was being introduced. And I have to say, I've been less than impressed by IRd saying we want you to do this more frequently and we're going to remove you the ability to cover your costs of doing so. So again, it's why I like how you've recognized that approach Nigel Jemson.

Now your proposal doesn't cover GST, but do you think there's scope for maybe having quarterly filing for GST in this?

Nigel Jemson
Well, I think it makes logical sense. I'm not saying I'd consider it in my original proposal, but I completely agree with this suggestion. You're dealing with essentially the same set of financial information to calculate your quarterly income tax. So, it makes sense to do your GST at the same time. And I think that would further actually simplify taxpayer compliance costs every quarter. Only having to think about tax once would be it would be a step forward. You know, aside from payroll and other obligations, I think there would be good to incorporate both.

TB
Do you foresee any difficulties from that?

Nigel Jemson
Well, Inland Revenue might not be in favour because it's not getting GST returns as often if businesses filing GST monthly or bi-monthly. But then again, if the taxpayers are in this Trusted Taxpayer Regime it can actually see the information at any point. So, I don't know. I'm not too sure it would be a major issue.

TB
What's been the feedback about your proposal from Inland Revenue? Is it something policy officials have said they would explore? I mean, [Minister of Revenue] Stuart Nash I think handed over the cheque to you, didn't he? So, if he and if Inland Revenue are keen about this, how quickly do you think it could be implemented?

Nigel Jemson
I think some work would need to be done about implementation to flesh out more how Inland Revenue would benefit from the data and how they'd use it. And that would be quite key to the proposal being a success. You need to make sure that Inland Revenue will actually be able to use this information effectively. And because it's a new thing, there might be some time to build up that capability and work out what they need to do.

You'll also need to work with software providers as well, because they essentially would have to build this into Xero and MYOB, etc. to build this sort of gateway. And you can imagine there could be some technical difficulties and privacy issues and all that that would need to be sorted first.

I think the core concept of a quid pro quo, so some sort of some kind of benefit for a taxpayer that goes beyond their ordinary compliance obligations is quite an attractive proposition. I did get some feedback from one of the judges that maybe they weren't necessarily convinced on the benefits for Inland Revenue gaining access to this data. But they were attracted to the core idea of a taxpayer getting some benefit for essentially good behaviour.

So, the judge suggested maybe another option instead of Inland Revenue gaining access to information would be some sort of systems audit. This would allow Inland Revenue to gain confidence about how good is their tax compliance framework and how they are meeting their tax obligations.

I think a barrier to the proposal being implemented would be because it has an incentive. Our traditional thinking is not favouring widespread use of incentives in the tax system because these introduces distortions. I think there are some good reasons for that. I'm just saying that the incentive is another useful weapon that can be used from time to time to enhance taxpayer compliance and benefit the tax system. And especially if you're moving to something like real time access to taxpayer financial information, you would have to actually deliver some sort of quid pro quo to the taxpayer. Otherwise, I think there'd be outrage.

TB
Well, I mean, I think you're right that it's this whole question of voluntary compliance, but also a quid pro quo. Inland Revenue's Business Transformation program has greatly simplified its administration costs. But a cynical tax agent such as myself might say that actually some of those costs are being passed down the line to ourselves.

So, if you're wanting to encourage compliance and we all do, because Gresham's law applies and bad money drives out the good, you want to encourage behaviour like this. And that's why I think the Trusted Taxpayer really appeals because, yes, there is an incentive which we regard as distortionary. But think of it also as recognizing our role in the smooth running of the tax system. And I think also fiscal costs might not be that great because you're getting four tax payments a year as opposed to three. So better management of cash flows.

Well, this has been an absolutely fascinating discussion Nigel Jemson. I really appreciate you taking the time to talk and congratulations again on your win. I hope you have put the money to good use. I hope we hear more about this. No doubt you were a very bright future ahead of you. So, thank you again for joining us, Nigel Jemson.

Well, that's it for the week in tax. I'm Terry Baucher and you can find this podcast on my website www.baucher.tax or wherever you get your podcasts. Please send me your feedback and tell your friends and clients. Until next time have a great week. Ka kite āno.

This article is a transcript of the February 28, 2020 edition of The Week In Tax, a podcast by Terry Baucher. This transcript is here with permission and has been lightly edited for clarity.

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