The Week in Tax: Inland Revenue fires a warning shot at real estate agents, the IMF wades into the housing debate, and more year-end tax issues

Last week Inland Revenue issued a press release warning real estate agents that this was an area that its analysis “suggests real estate estates, salespeople, slash agents commonly claim high level of expenses relative to their income. Inland Revenue believes the issue is widespread and we must act. People are claiming private expenditure, but not keeping logbooks or other business records to support the claim.”

The release goes on to warn that if someone has over claimed expenses in Inland Revenue’s view, “they will receive a letter from us requesting they prove the expenses claimed.”

Now, this is a little bit unusual from Inland Revenue because we haven't heard anything in the grapevine that this was something they were looking at. But it is not entirely surprising because one thing that emerged from hearing the Commissioner of Inland Revenue speak at the excellent Accountants and Tax Agents Institute of New Zealand conference is that Inland Revenue has great faith in its Business Transformation systems. These give it the ability to analyse data and identify areas where it believes income is either being under declared or in this case, taxpayers are, shall we say, being overly generous in their calculation of the deduction available.

Although, as I mentioned, we haven't previously had an indication Inland Revenue viewed this as an issue, it's apparent from what they've said here, that they've done enough preliminary work to identify that expenses being claimed by real estate agents seem high relative to income.

In one way I think this is a positive development in that I think Inland Revenue by warning people what it can do, can clear out some of the chaff.

On the other hand, there's a lack of specific detail in this press release which concerns me. It's “We think there's an issue, but we haven't actually specified what particularly is concerning us”. And simply to say that people claim a high level of expenses relative to their income is to assume that that expenses automatically should follow income. It could well be that there is a fair amount of baseline expenditure that people would incur in this business, running around making phone calls, driving to see clients and the like sometimes without actually a great deal of success, as the real estate sector is largely a commission only based.

And so one of the things that taxpayers perhaps should consider is the implications of Inland Revenue’s capability to do a great deal of analysis. One thing Inland Revenue could do is to start saying, “Well, here is a standard deduction. You can claim X amount which to we're going to accept as deductible without the need to keep very detailed records because our indication is that is likely to be the level of expenditure you would incur in your business.”

Now, Inland Revenue will come straight back and say they don't want to do that because people will abuse that. But on the other hand, you've got to wonder the benefit of the current approach when you consider the time and energy put in by people preparing their tax returns and also the effort Inland Revenue then spends investigating what may well turn out to be an entirely legitimate expenditure. Maybe just simplifying matters all around would be more efficient.

It could be yes, there could be some seepage around the edges under a different approach and Inland Revenue doesn't get as much as it could do if the rules were applied correctly. But applying a so-called standard deductions approach deals with an issue in the tax system, in that compliance is particularly onerous for smaller businesses. The rules are written around the expectation that people have a good understanding of the law and have the systems to manage their accounting and recording income and expenditure. And with the advent of online accounting systems such as Xero and MYOB that's largely true.

But not everyone wants or needs to spend money on accountants. And I have felt for some time that adopting a different approach to what we call micro businesses, that is businesses with a turnover of, say, less than $100,000 dollars would actually benefit everyone. Make it easier to comply and encourage more people to comply.

Anyway, we'll watch with interest to see how this plays out with Inland Revenue. As I said, I'd like to see some more specific examples of the abuse that they are clearly warning against. But until some cases hit the courts or Inland Revenue releases some more information on the matter, we'll just have to wait and see. In the meantime, it's a good warning for anyone involved in business that you have to keep accurate records of your business expenditure.

The IMF wants tax action on overheated housing market

Moving on, the IMF, the International Monetary Fund, has waded into the debate over housing by recommending the Government should introduce a stamp duty or a more comprehensive capital gains tax to help deal with the overheated property market.

This is part of a routine check on the New Zealand economy, what’s called the Article IV discussions. These happen periodically when IMF staff come down here, talk to Treasury and other officials and draw their own conclusions on the state of the New Zealand economy and areas for improvement.

The Government will not welcome the call for a capital gains tax or stamp duties. We haven't had stamp duties in nearly 30 years now, but they are used a tool used elsewhere. They've fallen out of fashion here because they are regarded as economically inefficient taxes, and there are concerns that they increase costs for purchasers. So as a means of helping first home buyers, a stamp duty isn't necessarily going to be a great approach according to theory.

But for those who've read Tax and Fairness, the book I co-wrote with Deborah Russell MP, you'll know that in Chapter Four, we talked about extensively how the IMF is not the first organisation to have raised the need for a capital gains tax to deal with housing inflation. The OECD raised the idea way, way back at the start of the century in November 2000 and then again in 2011, and the IMF also made similar suggestions back in February 2016.

I was going to say it's really quite remarkable how this issue keeps popping up, but actually it's not because the issues around tax were identified decades ago but have not been addressed. And meantime, the pressure on the Government builds now that the housing market has accelerated again. And this week (Tuesday) the Government will announce some proposed disincentives for property investors to try and reduce demand in the sector together with some form of targeted incentives to encourage savings in other sectors.

Just a little note on this, way back in 2000 the OECD concluded there was substantial overinvesting in housing, maybe one and a half times greater than that of major OECD countries. Now, I imagine that number has actually become considerably worse. So, as I've said before, the capital gains tax debate is not going to go away.

And on that debate, this coming Thursday, March 25th, I'll be on a panel alongside Geof Nightingale of PWC and the Tax Working Group and Paul Dunn of EY together with Craig Elliffe and Julie Cassidy from Auckland University. Our topic is “Taxation: the ticking time bomb of our generation. Four tax questions for 2021”. This is an event run by the New Zealand Centre for Law Business I have no doubt whatsoever we will be talking about the issue of capital taxation.

End of year prep

And finally, more on one specific issue which will require action before 31st of March, and that is the question of overdrawn shareholder current accounts.

Now, this happens when a director or a shareholder of a company takes out more in cash from the company during the year. This is traditionally treated as drawings. So, prior to yearend, we take a look to see what we can do. And most times we deal with this issue by either paying a dividend before year-end (a particularly important thing to do this year before tax rates increase on 1st April) or voting a shareholder employee's salary.

But in some cases, that is not enough. And in those situations, a company is required to charge interest using the FBT prescribed rate of interest. Now this rate is regularly adjusted and generally reflects what's going on elsewhere in the market. Until 30th June 2020, the rate was 5.26%. It was then reduced to 4.5%, the lowest rate I can recall. This is the rate that should apply from 1st July 2020 right through until 31st March 2021.

But from 1st April the rate increases to 5.77%, something that has slipped under the radar and possibly reflects Inland Revenue unease about the use of current accounts to get around higher tax rates. On the face of it a rate increase in this low interest economy seems anomalous.

But as I said, I think it reflects Inland Revenue concern about the use of an overdrawn current account to get around income being taxed at either 33%, or from 1st of April, 39%. In some other jurisdictions the amount of an overdrawn current account is treated as a dividend. Our rules treat only require charging of interest. So if you've got an overdrawn current account of $100,000 in Australia, that's going to be taxed as income of $100,000. Here we apply the FBT prescribed rate of interest of 4.5% so the taxable income is just $4,500.

So you can see there is some form of incentive to make use of overdrawn current accounts. In fact Inland Revenue has started paying a lot more attention to this issue and this small but quite subtle and unnoticed rate increase in the prescribed rate of interest is probably a clue it is planning to take greater action on the matter.

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!