In the Week in Tax Terry Baucher looks at unexpected tax bills for returning New Zealanders, time to simplify fringe benefits tax and a potential breakthrough on international tax

Friday was Small Business Day. If you spent money with a participating small business and posted your interchange on social media, you and the business could have won a share of $200,000 dollars. Now, this is part of an initiative underlining the importance of small businesses in the New Zealand economy.

MBIE defines a small business as one with fewer than 20 employees. And according to Stats New Zealand, there are approximately 530,000 small businesses in New Zealand meeting that definition. They represent 97% of all firms, account for 28% of employment and just over a quarter of New Zealand's GDP.

So they're very important to the economy, but most importantly, also for the community. When small businesses move out, the community suffers. So this sort of initiative and the work we were doing during my time with the Small Business Council is important for the economy.

However, when it comes to the tax system there's actually very few concessions for small businesses. That is part of a deliberate policy, which generally I and most tax experts support, of minimising special exemptions and in doing so, focusing on the basics. And by minimising removing special exemptions, you eliminate the opportunities for people to try and rort the system.

But that comes at a cost for small businesses of greater compliance costs. Compliance costs will always fall heavily on small businesses because they are generally quite under-resourced to deal with this matter.

Now as I said currently our tax system generally makes no concessions for small businesses. However, there is one such example which does apply, and that is the shareholder-employee regime. Under this regime a shareholder who is also an employee of a company can instead of having their salary taxed through pay as you earn, opt to pay provisional tax. Their taxable income can then be determined after the end of the tax year.

It's a very flexible regime, but it doesn't always fit well with the general scheme of the Income Tax Act. And I think Inland Revenue may be thinking in terms of such businesses should actually be in the look through company regime. The problem is these special regimes add complexity.

The tax loss carryback regime, which is temporarily in place for the 2020 and 2021 income years, proved unworkable for shareholder employees. They'd already taken profits out of the business by way of a salary. So if the company had a loss in either of those later years and tried carrying it back, it had no income to offset against the loss. So, it was of no use to shareholders employees.

When other tax practitioners and I were discussing a permanent iteration of the current loss carryback regime with Inland Revenue policy a huge stumbling block was the question of the treatment of shareholder employees. In fact, it proved unworkable in the end. And last month the Minister of Revenue revealed a permanent iteration of the scheme is not going to be implemented.

In my view one of the side effects of not having specific small business regimes, is that is that Inland Revenue policymakers don't pay enough attention to what's going on in the small business sector, and that means compliance costs creep up for the sector as issues are not addressed. And in the last week, we've had a couple of good examples of how this has played out.

Covid-19 has revealed, a number of things that should have been addressed in relation to employer employee relationships, but for whatever reason had been parked as there was always something more interesting to work on. These strains have started to come through recently.

There was a story in the Herald (paywalled) about a very common thing, Kiwis coming back to New Zealand, but continuing to work for overseas based employers. And what's happening is that a number of these are potentially facing double taxation, hopefully temporarily, and they understandably are confused about how much they own to which government.

One key concern is if an employee of an overseas employer is in New Zealand for more than 183 days, then technically the employer will need to start accounting for pay as you earn. However, in the meantime, that overseas jurisdiction may still be applying its equivalent of pay as you earn to the employee's earnings. So there’s a risk of double taxation risk.

And one of the other problems is with foreign tax credits. Technically, under double tax agreements an employment becomes is taxable only in the jurisdiction in which it's being exercised. So as the Herald article pointed out, in a worst case scenario, what can happen is that someone working in New Zealand for an overseas employer may have earned $100,000 dollars and paid UK pay as you earn, but won't get any credit for it in New Zealand. Inland Revenue’s view is “Well, you've earned $100,000. This is the tax bill, pay it.” Meantime, the problem that particular employee faces is that he or she have to then go and get the overpaid UK tax refunded. And of course, that can take some time.

And it may also involve getting assistance through what we call the mutual agreement procedures between Inland Revenue here and the UK's HM Revenue & Customs.  All this takes a lot of time and a lot of stress. It's a very good example of how the system is evolved, where it really isn't terribly flexible, and issues arise. One answer is to put people into the Provisional tax regime. Another one is for such employees of overseas companies to register themselves for pay as you earn or what they call an IR56 taxpayer.

Now just to clarify, we're assuming that the employee is just of the overseas company, is just an employee, and we're not dealing with the issues of that employee having sufficient authority to create what we call a permanent establishment, which is a whole other raft of issues, but are not relevant to this particular discussion.

Now, this particular issue is particularly problematic when it comes to New Zealand employees of United States employers.  The United States tax system is, to put it mildly, probably the most complicated in the world especially in contrast to our regime. It is full of special exemptions and procedurally as well, the Internal Revenue Service (the IRS) is a slow-moving beast.

Issues are starting to emerge where the IRS is expecting the US employer to deduct the US equivalent of pay as you earn. Meanwhile Inland Revenue here wants its cut and although the double tax agreement will give most taxing rights to New Zealand the IRS is very cumbersome in moving to say to the US employer, “Oh, yes, that's now foreign sourced income so you no longer need to deduct tax.”

And then there's the other issue I mentioned that the overseas company, could be treated as an employer and required to deduct PAYE in New Zealand. Now, fortunately, in that respect, Inland Revenue has a draft operational statement, which was released for consultation last year which deals with this issue of non-resident employers’ obligations to deduct pay as you earn, pay FBT and deduct employer superannuation contribution tax. The deadline for comments closed on it on 1st September so we ought to be seeing it fairly soon in final form.

And basically, Inland Revenue is saying an overseas employer isn’t going to need to apply PAYE so long as the employee's presence does not create a permanent establishment or as the operational statement has it, “a sufficient presence.” So that's a good solution. But I think this illustrates the problems with small businesses overseas and here of dealing with issues around tax systems that weren't designed with such matters and are slow to respond.

And that leads on to a second related point, the question of fringe benefit tax and the new 39% tax rate, which came into effect on 1st April. As a consequence of the change in the tax rate, a new flat rate of FBT of 63.93% applies to non-cash employee benefits such as discounted goods and services and private use of company cars. But that only applies in in reality to employees earning more than $180,000, which is only 2% of earners. 

But the FBT system expects employers to pay using a single rate which prior to 1st April was 49.25%. And so the increase to 63.93% represents a substantial burden. Now, it's possible to work around that and not use the flat FBT rate by filing quarterly FBT returns and calculating FBT on an attributed basis, i.e. for each employee.

So, yes, that's a solution, but it lead back to my point at the start of this podcast it adds to complexity of the tax system and also increases the burden of compliance with small businesses. So I think the point has been reached in our system that going forward, Inland Revenue really should have a hard think about the fringe benefit tax compliance costs for small businesses.

Leaving aside the separate issue of how well FBT is being complied with, particularly in relation to work related vehicle, it does involve a fair amount of compliance for small businesses. The FBT regime dates from the mid-80s and I think it's time for a rethink. In the 1980s it was probably a sensible approach that the employer paid FBT. Maybe now with better procedures in place, what should happen is that the employer calculates the value of the fringe benefit and that amount is then included as part of an employee's salary and taxed at the relevant rate. This would immediately deal with the issue of applying this new 63.93%rate.

But that's something that needs to be considered, perhaps as part a whole package of looking at compliance for small businesses. And I understand there is something in the works on that which we will be watching with great interest and report back on when we hear something in due course.

And finally this week, we've talked in the past about the international tax regime striving to try with the digital economy and each tax jurisdiction trying to find an appropriate level of taxation relative to a company's economic activity in a country. The focus is on the GAFA, as they call Google, Apple, Facebook and Amazon. 

Here in New Zealand these companies pay very little tax. Facebook does not publish financial statements in New Zealand, and Google's accounts to December 2019 show that its revenue in New Zealand was  $36.2 million. And it finished up, paying $3.6 million in income tax. That was actually an increase in from the 2018 year, where it paid around $400,000. But Google's revenue from New Zealand is considerably more than $36 million.

And what's happening here is replicated all around the world. So the OECD has been looking at this in conjunction with the G20 group of nations. This is part of a shift to try and stop the aggressive use of tax havens to minimise multinationals’ corporate tax bills. And this past week after a meeting of G20 finance ministers there appears to have been a breakthrough in that they are now exploring the equivalent of a global minimum tax on corporate profits. 

What's encouraging about this is that the US Treasury Secretary Janet Yellen, initiated the proposal, and this is a rapid, significant change from the Trump administration. There will be pushback on this, obviously, because certain jurisdictions and Ireland has been mentioned as one who already have a fairly low tax rate, concerned that their current 12.5% corporate tax rate may rise.

And obviously, tax havens will be looking at this with some unease. But my personal view is that the days of the tax havens are numbered because of the double impact of the Global Financial Crisis and Covid-19 anyway. It remains to be seen how well this will develop, but it is an encouraging sign. It might not actually make a great deal of difference to the New Zealand Government's books, but it will certainly be a step forward in the right direction. As always, we will bring you developments as they happen.

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 Ka kite ano!