Te wiki o te tāke: Bright-line test rollover relief, Inland Revenue consults on land taxation and cross border worker issues, and what could be the fallout from the Pandora Papers?

It's been a busy couple of weeks in the tax world. Last week, the relevant legislation for the interest limitation rules was released in a Supplementary Order Paper, and on the same day, probably not by coincidence as one or two other tax advisors have noted, Inland Revenue released a draft interpretation statement concerning whether, and if so to what extent, the land sales rules in the Income Tax Act 2007 apply to changes to co-ownership, subdivisions of land and changes of trustees. Coming out on the same day as the interest limitation legislation it certainly has given us plenty to chew on.

Furthermore, Inland Revenue has kept busy this week with an issues paper seeking feedback on a number of matters facing employers and payers of cross-border workers.  The whole week kicked off with the Pandora Papers, reigniting the debate over New Zealand's controversial foreign trust regime.

Property transfers between associated people

As we discussed last week, the Supplementary Order Paper with the relevant draft legislation for the interest limitation rules was released, and submissions are open to the Finance and Expenditure Committee until 9th November.  So, you've got approximately five weeks to get in and make submissions on these draft rules. I expect there will be some changes as a result of submissions and certainly I encourage everyone who has an interest in this area to make submissions with the aim of trying to improve the legislation.

Included in the Supplementary Order Paper is something which begins to address an issue which has been in place since the bright-line test was introduced in October 2015. And that is when there is a transfer between associated persons. Say for example, a person holds a property and transfers it into a trust or a look through company. As the legislation presently stands, that transfer would reset the clock for the bright-line test. So, a property that might be known for many years - more than 10 years for example – which has been transferred to an associated entity and therefore economically, when you look at it, no real change of ownership has happened. But for the bright-line test purposes there has been a deemed change of ownership and therefore the clock gets reset.

Now this was a problem identified way back in 2015, and the Supplementary Order Paper begins to address it by having some new rollover relief rules, which will apply from 1st April 2022. However, the rules are very complicated, particularly in relation to the transfer for a trust. And it could be really quite problematic for trust resettlements because the transfer to the trust must be a beneficiary who is also a natural person and can qualify for the main home exclusion. There's quite a bit of detail to unpack in there.

In fairness this is an improvement on the original proposal we saw when in consultation with Inland Revenue earlier this year, but it still has a number of complexities and traps which will make it not particularly user friendly. So, although it’s a step in the right direction, this is one area I would very definitely recommend people make submissions on.

Land sales tax rules

Now, the other thing that was released on the same day as the Supplementary Order Paper, was a draft interpretation statement - nearly 60 pages - on how the land sale rules in the Income Tax Act might apply changes to co-ownership, subdivisions and changes of trustees.

This is an extremely important paper because it addresses issues where there was some broad understanding of what the position might be, but it's good to see Inland Revenue set out its position.

Now the starting point to bear in mind is that income tax legislation in dealing with land transactions, refers to “disposals”, not sales. And this is the issue that the draft interpretation statement is addressing - what happens if there are transfers between co-owners, for example, does that create a disposal for tax purposes?

Now, quick digression here. The paper refers to tenancy in common and joint tenancies. A tenancy in common is where each party owns a distinct share, i.e. 50% or a one third share. A joint tenancy is where the land is owned by the parties together, but there's no specific shares, in which case each person has a notional proportional share. So, for example, if there are two joint tenants each has a notional 50% share. And if there are five joint tenants, each has a notional 20% and so on.

What the interpretation statement goes through is what happens if there's changes to types of co-ownership. For example, instead of owning it 50-50, they go to one party owning a one third share and the other party having a two-thirds share. Or there are two people and a third person is introduced or there are three people, and then one decides to.

What the interpretation statement says if it's the type of co-ownership and the proportional notional changes don't change, there isn't a disposal under the land sale rules, so that means there's no tax implications on the transfer. So, for example, if A and B were tenants in common with 50% each and they then moved to being joint tenants with again the notional 50%, there's no disposal.

On the other hand, if, for example, A had 25% and B had 75% under a tenancy in common and then moved to 50:50, then B has disposed of 25% interest, and this disposal, could be taxable. And here's where the issue gets quite tricky because this sort of transaction may be done on paper and no cash may change hands.  People have got to be very careful that if they are changing the proportions of how they own property, that they don't trigger a tax charge and find themselves with a tax bill, but no cash has actually changed hands to enable payment of any tax which may become due.

To recap, if there's a change in the form of ownership where the proportional and notional shares don't change, that's not a disposal. But if there is transfer, that adds a new co-owner, for example, that would be a disposal. And likewise, if there's a transfer that removes a co-owner, that's also a disposal. There's a lot to consider in this paper and we'll need to pore over it very carefully. But at least it gives us some guidance to work with. Submissions are open until 9th November.

Cross border workers

Earlier this week, Inland Revenue released another issues paper this time dealing with cross-border workers and identifying issues for reform. Work on this has probably been accelerated because of what's happened with COVID, which has disrupted work and travel patterns. In the words of the issues paper,

“It has also highlighted the role of technology in enabling cross-border work arrangements. The pandemic has accelerated existing trends affecting how, when, and where people work and technologies such as artificial intelligence and the greater use of contracts. The supply of personal services will be increasingly important drivers in the future.”

Against that background, Inland Revenue have been looking at reviewing the tax obligations that apply to payers of cross-border workers. And this paper focuses on what happens for employers and payments to independent contractors. This is an issue I've encountered quite a bit recently, as people have migrated to New Zealand but continue to work remotely for their overseas employer.

The paper begins by looking at the current PAYE rules. And it concludes that these are inflexible. One of the big issues is that we have arrangements concerning our double tax agreements where a person who is deemed to be non-resident but working in New Zealand and can be paid by their overseas employer for up to 183 days without triggering PAYE.

But currently under the PAYE rules, when they cross that 183-day threshold then after the day count is breached, the employer is required to correct the tax position not just going forward but also from the first day the employee was present in New Zealand. So, it could be several months later when the position is realised. And this means employers get additional compliance costs and could also be potentially subject to shortfall penalties and use of money interest. All in all, pretty much a compliance nightmare.

Inland Revenue recognise this needs to be reviewed because it's simply not always practical to collect PAYE from the income of cross-border employees. It’s hoping to allow greater flexibility for employees. And one of the things they're proposing is a new period of time for correcting a situation, which is 28 days from the employer first becoming aware that this day count threshold that I mentioned earlier has been breached.

To use an example from the issues paper, Estella a Brazilian tax resident, comes to New Zealand on a 10-week assignment, 70 days, to work on a construction project. It’s anticipated that the 92-day exemption, which is part of our Income Tax Act, will apply. We don't have a double tax agreement with Brazil yet, so this 92-day exemption is only one available.

But the project gets delayed and now extends beyond the 92-day exemption to 98 days and a catch-up payment for PAYE is therefore required. And no penalties should arise so long as this is done within 28 days of identifying that there will be a breach of the 92-day threshold. That’s one of the issues Inland Revenue are looking at.

They’re also looking at non-resident contractors. There's another set of rules that apply to independent contractors working in New Zealand. Currently, non-resident contractors’ tax is 15% and the New Zealand resident payer is required to withhold that from each contract payment made to a non-resident contractor.

The thresholds and rates haven’t been changed since 2003. Those thresholds, by the way, were adopted and in the wake of the Lord of the Rings when a large number of American productions came to New Zealand in the early 2000s and encountered this issue and work was done to mitigate those issues. It’s therefore probably time to have a look at these issues again. And it's good to see that Inland Revenue putting some ideas out there. Submissions on this are open until 19th November.

New Zealand's controversial foreign trust regime

As I mentioned the week kicked off with the Pandora Papers revelations. This reignited the debate over New Zealand's foreign trust rules. Now, when the extent of the use of New Zealand based foreign trusts was revealed in 2016 in the wake of the Panama Papers, the then government moved very quickly to tighten regulations.

And as a result of that, the estimated numbers of foreign trusts registered with Inland Revenue fell from about 13,000 back in 2016 to just over 4,000 now. The Pandora Papers will reignite debate about these rules.

These foreign trusts exist as a by-product of changes made to New Zealand's taxation regime for trusts in 1988. That’s when New Zealand switched from taxing trusts based on the residency of the trustees to taxing on the basis of the residency of the settlor (the person who established it).

Now the reason behind this was to tackle what was seen as quite substantial tax avoidance by New Zealand tax residents, and by and large, that move was highly successful. It is practically impossible now for any New Zealand tax resident to set up a trust now in a tax haven and shelter income from New Zealand tax.

But an accidental by-product of the regime was that non-New Zealand residents are able to establish such trusts. What they would do is settle a trust under New Zealand law with New Zealand trustees. Under the foreign trust regime, income from outside New Zealand would not be taxable. Which, by the way, is legal and consistent with general tax principles around the world - that is you tax residents on a global basis, or you tax income with a source in the country. So, for example, New Zealand taxes income with a New Zealand source and New Zealand residents.

If you have rules as New Zealand established, which say, “Well, we don't deem this trust to be tax resident in New Zealand”, then offshore income becomes tax exempt in New Zealand. And so, this is quite attractive because it meant that New Zealand essentially became an onshore tax haven for sheltering income.

So, it's quite controversial, and started to attract quite a lot of attention.  In part because of growing unease with tax havens we saw the introduction of the Common Reporting Standards on the Automatic Exchange of Information. New Zealand’s current foreign trust disclosure rules are in line with those standards.

The Panama Papers gave a boost to those rules, and I'm sure the Pandora Papers will also lead to further tightening as well. Although the Minister of Revenue didn’t seem particularly enthusiastic about moving very quickly on the matter, there’s a lot going on as we have discussed.  In any case, the position is that the number of trusts registered with Inland Revenue has fallen by two thirds since 2016 to just over 4,000.  The argument would be that a fair amount of the more dubious entities have been weeded out.

But what’s common in moves around the world and it ties into anti-money laundering moves particularly in Europe is for establishment of trust registers which is where details of these trusts are held.  Now whether they are held publicly like the Companies Office register, or privately and available only to Inland Revenue which is essentially what we are doing at the moment, needs considering. 

For those who are calling to tax these trusts what needs to be kept in mind is that often these foreign trusts are established partly on grounds of secrecy but also to ensure assets held in such a trust are outside two taxes, both of which New Zealand doesn't have. That is capital gains tax and estate duties.  Now these are transactional taxes, which are triggered by death or disposal.

So, when considering calls for New Zealand to tax foreign trusts we need to think about how we would practically do that given we don't have a general capital gains tax or estate duty. Basically, we would then be looking at a wealth tax or something akin to the foreign investment fund regime.   Whatever, there’s going to be quite a bit of debate on this going forward and it’s not going to die down very quickly.

Applications open

And finally, in Covid related news you have until 11:59pm on Thursday 14 October to apply for the fourth round of the August 20201 Wage Subsidy Scheme.  And applications for a third round of the Resurgence Support Payment are now open. To be eligible, your business must have experienced at least a 30% drop in revenue or a 30% decline in capital-raising ability over a 7-day period, due to an increase in Alert Levels.

• You can receive $1,500 per business plus $400 per full-time employee (FTE), up to 50 FTE.
• The maximum payment is $21,500.
• If you're a sole trader, you can receive a payment of up to $1,900.

If you’ve applied for previous Resurgence Support Payments and you’re eligible you can apply for this one.

Well, that's it for today. 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 week kia pai te wiki, have a great week!