Terry Baucher assesses the proposed income insurance scheme, the IRD's view on those who respond to the 39% disincentive, and the OECD's view on how we tax ourselves

The big news this week was the Government's proposed income insurance scheme. Interestingly, this is a joint approach between Business New Zealand, the New Zealand Council of Trade Unions and the Government. The idea had been floated in the run up to the 2020 election, and it appears in the wake of Covid-19 to be moving forward with some urgency.

Basically, the scheme proposes to pay members who lose their jobs up to 80% of their wages or salary for up to six months. As well as redundancy and layoffs it would also cover people who have lost their jobs due to health conditions and disabilities. It's also intended to provide coverage for contractors and the self-employed.

How it will work is if someone loses their job, the employer would need to give the scheme four weeks’ notice and pay the departing worker 80% of their salary wages for the first four weeks. And then if a worker doesn't find a job, they then start getting paid by the income insurance scheme for up to six months. It's going to be run by the Accident Compensation Corporation and operate in a similar principle to the existing ACC scheme.

How would it be paid for? Well, it's going to be funded by levies on wages and salaries for both employees, and the proposed rate is 1.39%, which is the current ACC employee levy rate.

This proposal represents a departure for New Zealand as it’s equivalent to a Social Security tax when we don't have those, although they're very common overseas. In fact, according to the OECD, New Zealand is one of only five countries within the OECD that doesn't have some form of Social Security tax. Social Security taxes overseas are used to fund schemes similar to the proposed income insurance scheme, but they may also cover other benefits such as pensions and general welfare.

As a result, the cost of these Social Security taxes can vary quite markedly. The highest as a percentage of labour costs is 26.6% in France, which is entirely borne by the employer. But there are eight other jurisdictions where the Social Security. Contributions can exceed 20% or more. And in five countries, including France and Germany, Social Security labour costs represent at least one third of all labour costs.

Across the OECD on average, Social Security taxes represent the equivalent of 9% of GDP. The proposed scheme is right down at the other end of the scale. It’s an initial step forward into an area where other jurisdictions have been for some time.

I know from my time working in the United Kingdom a lot of tax planning and tax avoidance went on around National Insurance Contributions. As these costs fall on employee and employers it isn't always welcome. Quite remarkably, some of the same stuff that I was seeing nearly 30 years ago is still going on.

On the other hand, it gives employees, contractors and the others affected some form of security. And as I said, this is a joint approach coming from Business New Zealand and the Council of Trade Unions. No doubt there will be plenty of politics playing out about it, but it's an interesting way forward and we will monitor the debate. Consultation has started and will continue until 26th April.

39% will bite a bigger group, who may respond to the disincentive

Moving on, earlier this week, it emerged that Inland Revenue had undertaken some analysis of the number of taxpayers affected by the increased 39% tax rate and had found the number of taxpayers who would be affected is some 44,000 more than initially estimated.

It initially thought it would be about 2% of the population, or about 75,000. But based on analysis of the tax returns filed so far for the year ended 31 March 2021 and current year PAYE returns and provisional tax payments, it appears the number is likely to be close to 119,000.   From the Government's perspective, this means that the tax take is going to be significantly higher than estimated.

The paper in which the Inland Revenue made this analysis has been released under the Official Information Act, and there's some very interesting commentary from Inland Revenue about what behaviour it is seeing in relation to the increased tax rate.  In the paper Inland Revenue comments

“it has extensive experience in monitoring compliance and 39% rate across 2003 circa 2010, which is the last time the individual marginal rate was significantly higher than the trust in company tax rates. Whilst we anticipate that similar trends and behaviours would be observed this year, we also have access to more real time data from which to derive insights.”

What it's saying there is, “Yeah, we’ve been here before. We've learnt the lessons from what happened when we last increased the tax rate, and we are ready to take action against what we see as potential attempts to manipulate taxable income to avoid paying that top rate”.

The paper then goes on to describe what happened prior to 31st March 2021, and quite predictably, it saw a large number of increased dividend payments to shareholders. According to Inland Revenue during the year to March 2021, $9.45 billion dollars was paid out in dividends to over 46,000 shareholders, representing an average of $204,000. The total amount of dividends paid out was nearly three times higher than the amount paid for the year ended 31 March 2020 and the number of dividend recipients was up 57%.

As the paper notes the likely driver behind paying out of dividends for the March 2021 yar was to ensure that they are subject to a maximum tax rate of 33%. The dividends probably represented a number of years of retained earnings rather than a higher-than-average earnings year in 2021. And then the Inland Revenue paper goes on to point out companies are entitled to pay dividends if they are in a position to do so. This was a legitimate option for them.

It's clear that people have taken steps to avoid dividends being taxed at 39% and Inland Revenue acknowledge this as entirely unsurprising. I've been around long enough to remember what happened the last time the tax rate was increased to 39% in March 2000. We did exactly the same thing. Significant dividends were paid out prior to the rate change. It's not tax avoidance. The paper makes this very clear. If companies could afford it, they could do it.

But where Inland Revenue’s analysis gets really interesting is it then starts to look to see if there's a decrease in employment income because as obviously people might say ‘I don't want to pay myself above the $180,000 threshold because I'm going to be taxed at 39%.’ Inland Revenue has carried out some initial analysis about what's been happening here. It has a split between what it terms customers who don't have an ownership or control association with their employer and those who do.

Interestingly, for the group without a control interest the total employment income for the year to March 2022 is estimated to be down 13%.  The number expected to be receiving over $180,000 is also expected to be down 9% to around 68,000. The average employment income of this group is going to fall from $228,000 to $217,000.

The paper then considers the group where there is an ownership control relationship with the employing entity, that is directors or shareholder-employees in the company. Inland Revenue estimates this group’s total employment income will fall by 15%, although there will be only a small change in the number of income people earning above $180,000. It’s expecting the average employment income for this group of people with control over a business will fall from $191,000 to $166,000.  

At which point the paper delivers this kicker “in an ordinary arm's length situation we wouldn't expect an employee's income to decrease (except to the extent in the current environment that they are impacted by COVID 19)”.

But as the paper notes in fact there is this fall in income. Inland Revenue is clearly flagging its concern and that, it's going to be looking at this issue when the returns for the March 2022 year start to be filed in another eight weeks or so, at the earliest. These are just projections from Inland Revenue, and it may be that these projections may change because of large end-of-year bonuses and other lump sum payments made towards the end of the year through the shareholder employee mechanism then. Whatever the reason Inland Revenue is basically running up a flag and saying, “We're watching.”

What it’s also been watching for is if there's been any restructuring to lower tax rates in what it terms “the target population” (the group of taxpayers with income over $180,000). And the paper says that since November 2020, this group has formed 10,633 new companies, 2,630 new trusts and 362 new partnerships. This represents “a 28% increase in the volume of new entities established by this population from the prior 12 month period.”

The paper goes on “Our next steps include integrating other data to further analyse these entities to identify any specific patterns or trends”. So again, Inland Revenue’s running up the red flag and saying, “We're watching”. The paper also points out that the new trust disclosure rules will give it further information.

And one other thing Inland Revenue has been picking up on is transfers of shares which have been previously held individually and but have been transferred to a company or a trust thing. What that is pointing out is if you held the shares individually, previously any dividend received would be taxed at 33%, but now would be taxed at 39%. But on the other hand, if it's held by a trust, the tax rate is capped at 33%.

Again, Inland Revenue is flagging that they're watching. As noted above Inland Revenue learnt a lot from what happened the last time the top tax rate was 39%. They were, to be frank, caught on the hop back then and the issue doesn't appear to have been picked up on until three or four years after the tax change happened. This time, Inland Revenue told the Government, you should increase the trustee tax rate to 39% as well.  Overall, the clear message here is Inland Revenue are watching and taxpayers should move with due caution as a result.

We are assessed by the OECD

And finally, in what's been a busy week, the OECD released its latest economic survey of New Zealand. The headlines focused on the OECD’s suggestion the Government scrap the first home buyers KiwiSaver withdrawals mechanism and various other policies targeted at first home buyers. Incidentally, at the start of the year the OECD released a paper on the taxation of housing which noted how owner occupied housing is very highly tax preferred.

The OECD economic survey reviews progress on four tax changes it’s previously recommended. One has been implemented in full and that is restricting the deductibility of property losses and not only allowing them to be offset against future rental income. That's been in place since 1st April 2019. It’s also recommended, as did the Tax Working Group, limiting KiwiSaver tax credits to low-income members.

The OECD has for a long time pushed the idea of a general capital gains tax, but as we all know, that has been knocked back repeatedly. The survey does note the bright-line test has now been extended to 10 years. The OECD’s other recommendation is for the mutual recognition of imputation and franking credits with Australia.  However, that's been held up on the Australian side because of the cost to Australia of such a move which would be of greater benefit to New Zealand companies.

Interestingly, the latest survey takes a look at environmental taxation, and it notes that revenue from environmentally related taxes in New Zealand is relatively low. This will probably come as a shock to everybody, but transport fuel costs taxes are lower than most other OECD countries, and most fossil fuel uses outside their sector are not taxed.

The OECD acknowledges more effective pricing of carbon and other greenhouse gas emissions should be pursued through the Emissions Trading Scheme. It suggests that taxation can be used to address environmental externalities that the Emissions Trading Scheme can't address. For example, taxes for fuels used in transport could be increased to “internalise social costs linked to transport such as local air pollution and congestion.” As technology improves congestion charging could be adopted.

The survey notes the Government is expanding the national waste disposal levy and is considering other environmental taxes. One option I've mentioned previously is perhaps we should be looking at fringe benefit tax being charged on the basis of emissions as is done in the UK and Ireland. Anyway, there are some very interesting recommendations and we might see more on environmental taxation as the year develops.

Well, that's it for this week. 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 send me your feedback and tell your friends and clients. Until next time, kia pai te wiki, have a great week.

Terry Baucher is an Auckland-based tax specialist with 25 years experience. He works with individuals and entities who have complex tax issues. Prior to starting his own business, he spent six years with one of the "Big Four' accountancy firms including a period advising Australian businesses how to do business in New Zealand. You can contact him here.