The Week in Tax - the state of Inland Revenue’s Business Transformation, Grant Robertson signals a crackdown on property speculation coming, and Inland Revenue’s latest view on tax avoidance

Inland Revenue for the past five years has been involved in a huge upgrade of its capabilities, what it calls its Business Transformation project.  This has been described by Treasury as “complex, high risk and fiscally significant”. The budget is for the project is $1.8 billion and it’s now into its final stages with the expectation that it will all be complete by early 2022.

Given the sheer scale of the project, Inland Revenue has been monitored very closely on its progress by Treasury and it has to provide regular reports to Cabinet on its progress.

The transformation status update for October and November 2020 has been published, and it makes for interesting reading.

The status of the programme is said to be light amber overall, which means that there are minor issues in some areas that can be resolved at the programme level.

What would be encouraging to Cabinet is that the project as of 30 June 2020, is $120 million dollars under budget. The cumulative spend to 30 June 2020 is $1,122 million and Stage Four, which is expected to be completed next year, is expected to cost a further $296.5 million.

IT projects will always attract a fair amount of criticism because they can and do overrun on costs substantially. It’s perhaps an unfair comparison, but it was interesting to see this morning that the costs to date of the Covid-19 tracer app have been estimated to be $6.4 million so far. Now, in fairness, the Covid-19 tracer app involves a significantly smaller scale of complexity than designing a system that's going to manage the tax affairs of six, seven or eight million taxpayers and has $80 billion plus running through it each year.

But at this stage, it would be fair to say that Inland Revenue seems pleased with the project’s progress so far given its budget and expectations. Although the latest update does state, “The temptation to overstretch Inland Revenue capability should be resisted until Business Transformation is closed.” In other words, we can do a lot more now, but don't be expecting us to do heaps more straight away.

But the more interesting document released at the same time was the Programme Business Case Addendum on Business Transformation.

What makes this particularly interesting is it gives more detail about what's been happening and sets out more reasons why the project is needed and the economic benefits for the Government.

These programme business cases are prepared annually, the previous one was prepared in October 2019 and this one in October 2020.  The most significant update is to the economic case. The commercial and management cases have also been updated, but no changes have been made to either strategic or financial cases for the project.

Digging into the document, you get an idea of Inland Revenue’s improved capabilities. It talks, for example, at some length about how it responded to the implementation of the Small Business Cash-Flow scheme. The scheme went live at one minute after midnight on 12th May 2020. Now it was 39 working days after the initial decision to begin some work, and then was just 10 working days from when the Government confirmed its intention on April 25th to when the scheme was launched.

In its first five to 10 minutes, it received 43 applications and by 1.20 AM, i.e. just a little bit more than an hour or so after it was launched, it had already received 600 applications. As of 9th October 2020, Inland Revenue had received 104,000 applications and approved $1.6 billion in loans. As I’ve said before and am happy to say again the Small Business Cash Flow Scheme is a very successful scheme and Inland Revenue do deserve a lot of credit for getting this up and running so quickly.

There’s a few wee snippets of things in the system that will need to be improved. The tax system overall. For example, you may remember that back in 2019 it emerged that a considerable number of people, 1.5 million in total, had the incorrect prescribed investor rate. Now, Inland Revenue got onto this and sent out 1.5 million letters saying, “Hey, you've got the wrong rate, either too low or too high so you need to contact your KiwiSaver provider to change it”, but only 15 per cent did so.

Fortunately, the law has been changed so that overpaid tax can now be credited, whereas previously if you'd overpaid under the prescribed investor rate regime, you lost it. So, that’s a good result.

But more importantly, and picking up a point I made last week, that the Inland Revenue tax policy work programme includes a look what is going on with charities, the donations tax credits process has been revamped. For the year to 31 March 2020, Inland Revenue identified 31,000 claims worth $23 million that were either an error or fraud in its view. And of that, 3,000 claims totalling $4.1 million were referred to audit teams to investigate.

So Inland Revenue’s ability to pick up and identify errors earlier and respond more quickly has been enhanced as a result of Business Transformation. Again, what you would hope to see and so far, so good.

The document sets out what Inland Revenue sees as the main benefit areas for the Government and who it calls “customers.” (In this document, customers are referred to 32 times and taxpayers just once). The main benefits are that it's going to be easier for taxpayers and the revenue system is much more resilient. You do wonder what could have happened to the old system given its state if a determined hacker had had a go. The Government now has greater ability to implement policy and that's very significant.

And then it gets into more nonmonetary and monetary benefits which is where it gets particularly interesting. It says the compliance effort has been reduced for small to medium sized businesses. Now, the methodology here is a little outdated. Inland Revenue hasn't run an up to date survey, but it does estimate that the median time SMEs spent on meeting their tax obligations was 36 hours back in 2013. It's expecting that Business Transformation will reduce that by 18 to 26 hours a year. And the cumulative value of the time saved will be over $1.3 billion dollars. It will run a new survey on this later this year.

The big expectation is that the amount of assessed crown revenue will increase $2.8 billion 30 June 2024. And that's a result of the efficiencies brought into the system, allowing earlier identification of non-compliance as well as easier compliance.

So far, this is the Inland Revenue estimates that to 30 June 2020 it has achieved $280 million of that $2.8 billion. This means over the next four financial years to 30 June 2024 it expects to achieve nearly $2.6 billion dollars of additional revenue.  In the year that ends on 30 June this year there will be another $290 million found. Then it substantially jumps up over the next three years with $600 million in the year to June 2022, $750 million in the year to June 2023 and almost one billion dollars in the year to June 2024. That’s a fairly significant amount of money coming in over the next three or four years, which Grant Robertson will be very grateful about. So Inland Revenue has made a rod for its own back, if you like, in terms of these ambitious additional tax revenue it expects.

Now, the other big benefit, and this is a source of some controversy when I spoke about before Christmas, is the cumulative administrative savings Inland Revenue expects to deliver. By June 2024 these are supposed to amount to $495 million.

Now, as of the date of this report, it's ahead of target, having achieved savings of $118 million compared to the target of $95 million. But it fell short by some $23 million of its target of $80 million for the year to June 2020. Inland Revenue is therefore hoping to save a further $370 million in the next four financial years, so the pressure will be on in that regard. So, again, you can expect the Government and ourselves to be paying particular attention to how that is progressing.

But there's one controversy about Business Transformation that I think’s important. The whole project cost has been enormous. And one of the concerns I would have about this is that New Zealand businesses, that is New Zealand owned businesses have by and large not had a great deal of input into this.  According to this report, about where it is spent between July 2014 and 2020 and where Inland Revenue spent more than $500,000 on contractors and consultants providing services across Business Transformation the total percentage spend on New Zealand companies was 36%.

(The contract, by the way, was awarded to a company called FAST based in the United States and Accenture Consulting, another multinational also provided assistance).

Now, if you include companies/contractors resident for tax purposes in New Zealand, then the total New Zealand percentage spend rises to 73%. In other words, although the Government has passed money through Inland Revenue to a business which is overseas owned that income, by and large, will be taxed in New Zealand. To give you some idea of just how much might be involved according to Inland Revenue’s June 2020 annual report the total spend for contractors and consultants was just under $183 million.

That's down, by the way, from $206 million dollars in the June 2019 year.

Now just picking up a point from my time on the Small Business Council, this is an area where we saw a lot of frustration from small businesses. They felt they could not get to deliver services to the Government through because of what they saw as excessive gatekeeping and bureaucracy involved in the industry.

New Zealand has a great IT industry just picking up and getting that point about the Covid-19 app that cost $6.4 million which is absolute peanuts. Apparently in Britain, they've spent £10 million on one app which was abandoned and do not appear to have anything that works as efficiently as our app. So, the capability is here.

And I feel that there was a great missed opportunity with Business Transformation. Hopefully going forward the percentage of New Zealand businesses that do get involved with the tail end of this work or new work as it arises, will be increased.

But the overall state you can take from this report is Inland Revenue considers Business Transformation is moving in the right direction. We'll need to pay attention to whether it will achieve its ambitious goals. But certainly, it feels it has the tools available to achieve what the Government will want, that is additional tax revenue to pay down the massive debt that's been run up because of Covid-19 and no doubt the huge spend going forward for maintaining our infrastructure and health services, as well as regular costs such as superannuation and education.

Robertson on property speculation

Moving on, the Finance Minister Grant Robertson made a speech to the BNZ on Tuesday, about the forthcoming Budget Policy Statement. In the course of his speech he said,

But we can do more or more to manage demand, particularly from those who are speculating New Zealanders are seeing family members being crowded out of the opportunity to purchase a home of their own by speculators and investors.

The housing boom and the resulting pressure on the rental market and vastly increased prices is a concern to the Government as it is getting shot at from all sides. So clearly, this statement from Grant Robertson was a reminder that Inland Revenue does have the tools, which it's s I've just explained, it feels it can do a lot more to look into the speculators.

And that leads on to the inevitable discussion of the bright-line test, which to quickly recap applies when any residential property is sold within five years of acquisition. The sale will be taxed unless an exemption applies.

Now, the bright-line test is one of a number of other property taxation clauses within the Income Tax Act. There is Section CB 6 which taxes property bought with an intention or purpose of sale.  The problem with the tax laws around the taxation of property is the absence of a comprehensive capital gains tax. There's a lot of subjective clauses involved. The bright line test is very largely unique in that it very specifically says if this happens, then it's taxable subject to exemptions.

On the other hand, section CB 6, which I just mentioned, talks about purpose or intent. There’s also section CB 12 which taxes a subdivision which involves work not of a minor nature.

And so, of course, you’ve got these subjective phrases.  And just to compound those issues is that when you drill into these sections, sometimes they will apply if that particular activity happens within 10 years of acquisition, but maybe within 10 years of a building being completed, the timeline isn’t always the same.

And the exemptions that may be available because it's a residence or business premises for example, vary as to who can use them. For example, there are four possible exemptions available to someone who's taxable under section CB 12, which is a subdivision which is not of a minor nature. But two of those exemptions don't apply if the person involved is a trust.

And so these inconsistencies and details around the varying times of which rules may apply and when give plenty work for people like myself. But notwithstanding that, they also point to the need for a complete rethink of those rules to bring clarification and some form of internal consistency. Why should one exemption apply to a property owned by a trust, but another exemption not? You would expect it to be consistent across the board. Now that it so happens that Inland Revenue does have such a project on its on its policy work programme. So, we can expect to see something maybe later this year or early next year.

Updating the IRD's view on what is tax avoidance

And finally, with the increase in the tax rate to 39% coming up, it's timely to consider the implications of trying to take steps to mitigate that. The Income Tax Act has a number of tax avoidance provisions which Inland Revenue can apply.  Sections BG 1 is the general anti avoidance provision and for those with very long memories who may recall the Penny Hooper case, involving a couple of surgeons, this was the provision applied.

Inland Revenue has got an Interpretation Statement on anti-avoidance but it was issued in 2005. It has now released an updated version for consultation.

And that update came with a five page information sheet, which when something like this comes with an information sheet, you know you're in for some particularly dense reading.

There's too much to cover right now so I'll pick it up at a later podcast when we have had a chance to consider it closely. But this is a reminder that the temptation will be to start making plans to mitigate the impact of the 39% rate. But you need to be aware of Inland Revenue’s possible response.  I'd therefore recommend every tax advisor has a close look at what this new draft interpretation statement is saying.

Well, on that happy note, that's it for this week. Thank you for listening. I’m Terry Baucher 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 week, ka kite āno.