The Week in Tax: Inland Revenue reminds tax agents about the bright-line test, responds to criticism. And the wealth tax debate continues

About 11 o'clock on Tuesday morning, myself and what appears to be just about every other tax agent in the country received an email from Inland Revenue with the subject line “Clients meeting the bright-line test”.

The email began: “Our records show the following clients have sold or transferred residential properties that meet the bright-line rule. This means these clients will be required to pay income tax on any profit they have made on the sale of the property.”

The email then set out the clients it believed were caught by the bright-line test rules. That is, they either sold property within two years of it being bought between 1st October 2015, and 28th March 2018 inclusive or within five years of it being bought on or after 29th March 2018.

Now readers and listeners will know that I have previously stated that we are aware that Inland Revenue has been gathering data in relation to the bright-line test. But this is the first time it's really flexed its muscles and its capability to show exactly what it knows about what's going on. And an insight into why Inland Revenue did that came the following Wednesday morning, when Stuff published a story under the banner headline “One in four property speculators dodging housing tax”.

Based on Inland Revenue data the story outlined that of 1701 property sales subject to bright-line test in the 2019 income year 1285 have paid up and complied, but Inland Revenue is looking at the other 416 taxpayers who appear not to have complied with the law. It's also looking at a further 3,758 sales for that year, where the bright-line test might apply.

This email initiative, as you might imagine, caused quite a bit of a stir amongst the tax agent community, and we know that all accountants from small companies like ourselves to major Big Four firms received these letters for their clients. Although the emails set out the client Inland Revenue believed was caught by the rules, they weren't any more specific than that.

This upset a few accountants because it means digging around to find out what's going on here. It also transpires that Inland Revenue may have been a little premature in its information release. Apparently, there is a follow up email coming next week, which will actually set out the address of the property in question so that we can then more accurately work out what's going on.

But there was a fairly lively debate about the matter on the Facebook page of the Accountants and Tax Agents Institute of New Zealand of which I'm a member.  And quite a few interesting snippets emerged about who had received emails and why.

Inland Revenue’s systems appear to have picked up any change in the registration of title. So that would include obviously sales where the title to the property passed to a new owner. But it also appears to have included changes in trustees because contrary to what a common misconception, trusts don't actually exist in law although they have a separate existence for tax purposes. But in law, the property is held by the trustees. So if you have individual trustees holding property and one retires, there has to be a change of registration on the title. And Inland Revenue systems have picked up a few of these and issued a “Please explain.” Overall, though, the majority of tax agents were reasonably happy that this was the sort of initiative that Inland Revenue should be doing.

I've said before that Inland Revenue has access to a lot of data but doesn't really make people aware of just what it knows. And these bright-line test emails are an example of it using the information it holds and making people aware of their obligations.  One or two accountants noted it was interesting to see a sale by that client because they never mentioned it to us. There was one particular case, I recall, where the client went ahead and did something which they thought would be outside of the bright-line test, but in fact the transaction was caught.  He was most crestfallen when he eventually spoke to me about the matter and I explained how the rules operated.

So this email initiative is the sort of thing that we can expect to see Inland Revenue doing more of and we can expect it to be fine tuning how it does these information releases. Yes, in some cases, such as those where there's just merely been a change of trustee, Inland Revenue has jumped the gun. Perhaps a little bit more thought around whether that particular transaction was caught would have saved some headaches and frantic calls between clients and accountants on the matter.

But when you consider the heat in the housing market and concerns everywhere amongst those locked out of the housing market and the desire for the government to raise revenue to fill the hole blown in its balance sheet by the Covid-19, it's not surprising Inland Revenue will be taking this initiative.  It reminds people, “Hey, these are the rules. We think you're caught. If not, please explain”. So, in summary, I think we'll see more of these initiatives further down the track

By the way, as a PR exercise, it does no harm. Firstly, it tells the new minister that it's on top of things and secondly, reminds those who think that Inland Revenue is big and dumb, that in fact, it has got access to a lot of information. And to borrow a line from Liam Neeson, it will find you and will, if not kill you, certainly tax you.

Communicating in public

Moving on, a couple of weeks back, myself and Andrea Black took a look at Inland Revenue Business Transformation programme, and we weren't terribly happy about some of what we found.

Well, on Tuesday, Sharon Thompson, Deputy Commissioner for Community Compliance Services, published a piece responding to our podcast.

And in particular, she addressed our suggestion the transformation hasn't been successful because cost savings haven't been reinvested into audit and investigation work. This was, “a narrow view of how Inland Revenue ensures tax revenue in New Zealand is as close as possible to what is required under our laws”. And our view that Inland Revenue’s current approach was incorrect is not supported by international research.

I think the phrase is “Shots fired!”, but it’s certainly intriguing to hear the Deputy Commissioner's response. One of the points she made in responding to the specific questions we raised about the level of spending on investigations and debt management, was “Our new system has dramatically increased and improved the data we have access to. And we can watch, often in real time, as taxpayers file returns. So, if they’re getting it wrong, accidentally or deliberately, we can see and intervene, reducing the need for post-return audit and investigation.”

That is something I've heard from other Inland Revenue staff.  If you file a tax return through the Inland Revenue portal, the system tracks the keystrokes. And in one example given to me last year by an Inland Revenue officer, if there is a suspiciously large number of adjustments being made to get the just right amount, they will look into it.

Sharon goes on to comment that every return that can generate a refund is checked automatically and amended returns are checked and screened. For example, between 1st July 2019 and 30th June 2020, Inland Revenue identified approximately 23,000 returns across all tax types which had errors or it believed were fraudulent with a value of just under $200 million. Now, that's a good initiative and Andrea and I would not dispute that was a good result and also a good use of Inland Revenue resources.

However, Sharon's article did not address the concerns that I've expressed previously and alluded to in the podcast with Andrea about Inland Revenue’s relationship with tax agents. Tax agents are vital to the operation of the tax system. But many other tax agents and I have reservations about how the new Business Transformation programme has integrated tax agents into its system.

The initiative I talked about a few minutes ago is something we would welcome, and we should expect to see that.  Tax agents are actually Inland Revenue eyes and ears and so we do a lot of the pre-screening that Inland Revenue would otherwise have to do without us.

But we don't always get access to Inland Revenue as easily as we should. The phone line for tax agents was abruptly turned off and then reinstated, but with limited hours, for example. So although Inland Revenue may feel that Andrea and I were unfair in some of our criticism, but equally, some of the criticism we raised still needs to be addressed.

The role of tax agents is one where tax agents have a great deal of concerns about what Inland Revenue expects and whether, in fact, it wants to work with tax agents going forward. My belief is Inland Revenue does, but it’s not communicating that very clearly to us at the moment.

I still feel that the dramatic fall in investigation hours of almost two thirds over the last five years is a matter for concern. But we will be able to see how Inland Revenue has worked through the Business Transformation process and see more of the numbers when its annual report is published shortly. It's been delayed, apparently in part down to the Covid-19 outbreak.

Tax on wealth vs tax on work

And finally, the debate around taxation and housing and wealth taxes continues to rage all week. On Tuesday, Westpac published its Economic Overview for November,  in which it made the point that future governments will be forced to either reduce spending or increase taxes because of the fiscal pressures that are starting to build over superannuation and health care.

The Report goes on.

“The required adjustments to our fiscal position can't be delayed forever. Sooner or later, some form of consolidation will be necessary, though the precise form this takes will depend on which party is leading the government at the time.  Our pick is that a future government will introduce some form of tax on assets such as a land tax, capital gains tax or a wealth tax. Societal concern about increasing wealth and inequality is only going to intensify, eventually creating a large constituency for such a tax. And tax experts agree that broadening the tax base would enhance economic efficiency.”

Later that afternoon, I spoke to Wallace Chapman on Radio New Zealand's The Panel about this report and the ins and outs of a wealth tax. And in addressing the housing crisis, I made the suggestion that maybe a 10% stamp duty might be imposed on all investors or some measure like that.

Now, last week, I mentioned a Deutsche Bank report which suggested a working from home tax which unsurprisingly got pooh poohed. But the full report is actually quite interesting and actually has one of the more dramatic report openings to any bank report I've seen in a long time:

“To save capitalism, we must help the young. Democratic capitalism is under threat as increasing numbers of young people view the system as rigged against them. The pandemic has only exacerbated their economic disadvantage.”

Now, that's quite an opening for any report, let alone something from a bank, but the report goes on to talk further about some tax changes and these proposals mirror what was suggested by Westpac. Deutsche Bank suggests that, for example, there is a need to have a tax on a primary residence, which if you think about the hoo-ha we had with the idea of a proposed capital gains tax taxing everything except the primary residence last year, you can imagine just how big a fight would happen if we said actually, “We're taxing the main home as well.”

The Report also suggested that there may need to be additional taxes on financial assets such as stocks, bonds, due to their gains from loose monetary policy. As maybe people are well aware, stock markets have actually boomed quite substantially this year. New Zealand’s stock market has been hitting record highs recently. The Deutsche Bank report, notes that in the 30 years to 2019, the S&P 500, that's the main index in the United States, gained over 800%, two thirds more than the return seen in three decades previously. The report suggests taxing such income on a basis similar to our foreign investment fund regime, and or remove exemptions and discounts and capital gains. Picking up my Stamp Duty proposal, the report suggests such duties are paid by the vendor and not, as is common, the purchaser.

Now, the point that the Report makes is the reason why it wants to increase the tax on capital is so as to avoid much higher income taxes, which are often cited as an argument against hard work. This is one of the criticisms of Labour's proposed tax rate increase to 39%. It is very narrow and hits income earners, whereas there’s a growing consensus that it’s the taxation of capital which needs to be broadened.

So this debate is going on all around the world. When banks like Westpac here and Deutsche Bank in Germany are making comments about broadening the scope of capital taxation you know a fundamental shift is happening in taxation thinking. How that will play out, we'll have to wait and see, and I'll bring you developments as we go.

Well, that's it for this week. Thank you for listening. I'm Terry Baucher and you can find this podcast on my website www.baucher.tax  or wherever you get your regular podcasts. Please continue to send me your feedback and tell your friends and clients.  Until next week, ka kite āno.

This article is a transcript of the November 20, 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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