The Week in Tax: a closer look at Inland Revenue operations. Is Google taking the government for a ride? And a warning about the new bright-line test

The chances are that if you ring Inland Revenue, your call will be answered by a contractor. Inland Revenue, as part of its Business Transformation programme, has been making increasing use of contractors and its use of contractors has led to a recently decided case in the Employment Court.

The Public Service Association took the case against Inland Revenue asking for more than 1,000 labour hire workers to be reclassified as direct employees of Inland Revenue. It took the case in the name of eight workers engaged by a labour hire company, Madison. And these people were mostly engaged to work as call centre staff at Inland Revenue.

Now, the case was decided by a full bench of the Employment Court, and it will be a very significant Employment Court decision. The decision itself, as published, runs to 82 pages. But what caught my eye about it was how much it revealed about the extent to which Inland Revenue is using contractors. As it transpired, Inland Revenue won the case. The court unanimously held that the labour hire workers were indeed employees of Madison and not of Inland Revenue.

But I doubt whether that's going to be the last we hear of it, given the scale of what's going on and the involvement of the Public Service Association. And I suspect this case will be appealed up through, the Court of Appeal and maybe ultimately to the Supreme Court. Hence probably why there was a full bench put on it of judges in the first place and the extremely extensive, and if you're an employment lawyer, no doubt very interesting legal arguments engaged.

But the reason why the PSA took the case was, as the National Secretary of the PSA, Kerry Davies, pointed out, the scale of contractors being used was new. Inland Revenue, like many government agencies, if not all of them, I would expect, does use temporary staff from time to time. And you can look back and you can see that there's been the use of contractors. For example, if I look back for the year ended 30 June 2015, contractors engaged by Inland Revenue cost a total of $45.3 million in that year.

But what's been going on with this one hire company, Madison, is quite extraordinary. The eight plaintiffs who were supported in the case by the PSA, had worked in various Inland Revenue offices for periods between seven and 15 months, and they were amongst a total of 1,233 workers hired out to Inland Revenue by Madison starting in 2018. Now, to put that number in context, at 30 June 2017, Inland Revenue’s headcount was 5,519. As of 30 June 2020, its headcount is 4,831. So 1,233 temporary employees represents a very significant number of staff, getting on for almost a quarter.

Not all were engaged the same time. But we do know that under one of the agreements (what they call work orders) In October 2018, Madison agreed to provide 382 client service officers, as well as another 83 client service assistants.

Now the obvious attraction for Inland Revenue in this was some cost reductions. For example, a contractor supplied by Madison would be paid $20.00 an hour compared with an Inland Revenue employee of $23.94. If the Madison worker gained competency, that's after a test which was taken usually after 12 weeks or so, they could go up to $22.50. Just for the record, Madison billed Inland Revenue over $40 million over two years. And it paid on average $29.25 per hour for a Madison worker who had gained competency and $26.00 per hour, exclusive of GST, if they hadn't.

All this is of great interest to me and my other tax agents because we have been experiencing a great deal of difficulty getting through to Inland Revenue and working with them under the new system. I'm also very curious as to where the benefits are flowing through on Business Transformation.

To give you an example, a lot of systems have been automated, but there's a great deal of inflexibility built into the system. Every tax agent I know, like myself, has encountered an issue where we directed a client to make a payment for a specific tax year, say, the 2019 income tax year, only to find Inland Revenue’s system had redirected that to another period. That then means that we have to pick up the phone, try and get through on a dedicated agent line - which has been cut back - and sort out the mess. Every tax agent I've spoken to has reported the same issue.

Therefore, the competency with which Inland Revenue approaches of its staff and the level of training they used is of great import to us as tax agents. We handle the more complex clients who also happen to bring in some significant amounts of tax revenue. So that's why I've looked very closely at this case and am very interested to see how it played out.

And I was very surprised by the numbers I encountered. I then decided to take a closer look at exactly what Inland Revenue has been doing in terms of its personnel costs. Looking at its annual reports covering the six-year period ending 30 June 2020 - that is the year ended 30 June 2015, just before Business Transformation started - through to 30 June 2020.

The numbers are revealing about what has been going on in terms of Inland Revenue staff levels and its personnel costs. On 30 June 2015, Inland Revenue had 5,820 employees, 98% of which were permanent. As of 30 June 2020, the headcount was now 4,831, a reduction of nearly a thousand. But the number of permanent employees had fallen to 84%, indicating quite a marked degree of temporary contracting going on.

Now total personnel costs for Inland Revenue, including contractors, for June 2015 were $463.7 million. In the year to June 2020 that had gone up to $547.8 million. Now, that is a surprise, given that over the same period, as I've just pointed out, the headcount at Inland Revenue has fallen by a thousand. And by the way, these numbers do not include the contractors engaged in relation to the Business Transformation project, which is about another $70 million annually.

in June 2015 year, the contractors and consultants cost Inland Revenue $45.3 million. In the year to June 2020 that had risen to $111.5 million. That was actually down from the peak year of June 2019 when it was $136.8 million. Interestingly, Inland Revenue personnel costs for June 2020 at $436.3 million are little changed from June 2015, when they were $418.4 million.  But what's important is if you look at the total personnel contracting costs. In June 2020 year, more than 20% of those costs represent contractors.

Summary contracting & personnel costs six years ended 30 June 2020

(Source Inland Revenue Annual Reports)

And by the way, over this six-year period, Inland Revenue has paid out more than $47 million in termination benefits. In the year to June 2020, it was $19.3 million and the year to June 2018 it was another $21 million.

There are a number of things that really concern me about what's gone on here. Inland Revenue does not seem to be showing significant improvements in cost efficiencies. It has a great reliance on temporary contractors beyond what you might expect for a short period. As I said at the beginning, use of contractors by Inland Revenue is not unusual. But here it seems to have become very, very significant.

And so that raises for me questions about whether, in fact, the Business Transformation programme is delivering what it should be or was intended to. And then there is the question that despite engaging all these temporary contractors in the call centres, Inland Revenue has been diverting resources from other parts to handle calls.

You will recall when I spoke with Andrea Black last year we talked about how the funding of investigations had fallen, the hours spent on investigations had fallen, and we knew that many investigation staff, who are very, very experienced, had been diverted to handle calls on the main call lines.

Now, interestingly, in the recently announced Budget Appropriations for 2021/22, the funding for investigations and management of debt and unfiled tax returns collectively were cut by $15.9 million going forward. However, the appropriation for processing costs has gone up by $10.4 million or 8% to $138 million. Now, again, this is a question which Andrea raised during our podcast. ‘Wait a minute, with this new system, should we not be seeing reduction in processing costs?’ But instead, we're seeing increasing processing costs.

So overall, although Inland Revenue won this case in the Employment Court, I think it has opened a can of potentially very interesting issues as to its use of contractors, and whether Business Transformation is delivering what it says it's supposed to be delivering.

So, I think we'll hear more on that in the coming weeks. I have no doubt that some questions will be raised around this at various levels. Certainly, the PSA will continue to pursue the case now.

Act now or wait for the OECD?

Moving on, last week I talked about how the Minister of Revenue David Parker had climbed into Google in particular over its tax practices. Now, it so happens this week, Google New Zealand's results for the year ended 31 December 2020 were released.

The data contained in there prompted one accountancy expert, Dr Victoria Plekhanova, to say that she considered that the government at present may be giving to big tech companies like Google and Facebook, a free ride on tax while it's waiting to see whether a coordinated OECD process we mentioned before, will bring a new order into the tax international tax regime.

Dr Plekhanova noted that the service fee paid by Google New Zealand to related parties offshore had increased from $511.4 million in 2019 to $517.1 million in 2020. Google reported revenue in New Zealand of $43.8 million, which was up from $36.2 million in 2019, and that its net profit for the year was $7.8 million, slightly down on last year's $8.12 million. In the end, it would be paying about $3.3 million in taxes, which was roughly the same as in 2019.

But as Dr Plekhanova pointed out, there's this significant amount of service fees going offshore, which is one of the matters that I'm sure Minister Parker is well aware of.

The other thing that caught my eye as well in this is that there's an amount due to related parties, which as of 31 December 2020, amounted to just over $78 million. And curiously, it's not like Google doesn't pay income tax it also pays a fairly significant amount of GST it appears. There's GST payable as of December of $8.5 million. Assuming it files GST returns monthly, which it should do, based on its turnover, that would point to maybe a total of $100 million of GST being payable annually, which is good. But that's probably being paid by businesses who will be claiming an input tax credit, so maybe there's no net revenue gain there.

Whatever it is, Dr Plekhanova made the argument that this is why digital services tax has become more attractive to various countries. India, for example, has a 6% equalisation levy and has recently imposed a further digital services tax, which drew the ire of the United States. Although India's response has pretty much been well, if you want to get access to 1.4 billion customers, this is how it's going to be. India is big enough to be able to tell the tech companies you play by our rules or else, but New Zealand can't.

So, the issue for us is whether the government is going to wait on the OECD rules coming in on a global minimum tax, which we talked about before, and agreeing a new basis for taxation or it decides to push forward with a digital services tax. I imagine that seeing Google's latest results may well prompt Mr Parker to move up the progress of a digital services tax.

Bright Line fish hook

And finally this week, there's a warning from the Chartered Accountants Australia and New Zealand's head of tax, John Cuthbertson, about an issue with the revised bright-line test.

What he's pointing out is that the changes are not just in the extension of the period to 10 years, but the revised rules will now explain how long homeowners can stay away from the main home before the bright-line test kicks in.

Under the new rules, as proposed, they are able to be away from the family home for a continuous period of up to a year. However, for some people, if they're seconded overseas or have a longer secondment down country, that might not be long enough. It may mean that if they sell within the 10-year period, they could find that some part of any capital gain could be taxed.

We're expecting a discussion document on these property tax changes very shortly. But as I've said beforehand, and this is another example, we know these rules are going to be complex. And this is why I've raised the argument that maybe we should be starting to think differently, adopting a completely different approach to the taxation of investment property. Anyway, when the new discussion document on these property tax changes emerges, we'll look at it in detail.

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 āno.