Terry Baucher investigates the Government's targets for its digital services tax, looks at what it means if you have a wrong PIR rate in your PIE, and watches as the IRD struggles to process all its tax refunds

This week in tax:

• The government proposes a digital services tax;
• 450,000 taxpayers get an unexpected slice of pie; and
• Inland Revenue is feeling the strain.

This week, the government released a discussion document on taxation of the digital economy. In particular, these are companies such as Facebook, Google, and the tech giants.

The discussion document is building on some work that was done for the Tax Working Group, and the main proposal is for a so-called digital services tax – a tax on the revenue of specific digital companies who cannot be taxed and who presently are undertaxed relative to other multinationals because of the way the tax rules have evolved over time. The arrival of the digital economy was simply not within the scope of those rules.

There’s been a longstanding project by the Organisation for Economic Co-operation and Development (OECD) on this known as Base Erosion and Profit Shifting (BEPS) and it’s been clonking along steadily in the background for the last six or seven years, making steady progress in changes to this.

The government recently brought in some of the proposals that have gone through the OECD process and have been agreed by the 30-odd countries within the OECD, including most critically the United States. The OECD last Friday, the 31st of May, released its next update on the digital economy – a program of work to develop a consensus solution to the tax challenges arising from the digitalisation of the economy.

The government’s discussion document is building on that. There are several proposals there, but the eye-catching one is something that’s been gaining a lot of momentum around the world – the digital services tax or DST.

The DST is generally levied at about between two to three percent of the estimated revenues from that digital company in a particular country. Many jurisdictions have been increasing. India has one. India is the largest country in the world with one. Britain has proposed one. The European Union has been looking at this, and France and Germany have been looking at this particular issue.

What is interesting in the DST is it’s designed as an interim measure whilst the OECD gets its act together and comes up with an agreed framework for everyone to follow, but that’s going to take some time. The pressure is on the finances of governments.

The paper notes in the EU, they calculate that a traditional multinational taxed on traditional lines pays roughly 23.5 percent tax as a tax rate on its profits whereas a digital company has just over nine percent. There’s a huge gap there. That’s something that over time the countries cannot allow to continue.

There is an estimate from the EU paper which is cited in the government’s discussion document which talks about mainly Germany, Italy, France, and Spain are losing perhaps up to 40 billion Euros a year in profits that are being shifted off into tax havens.

The idea behind the digital services tax is it’s an interim measure. We’re going to slap this in place and then it will be removed once a framework is agreed.

To give you some idea about the timing of it, the discussion document itself says that we are proposing this because we want to have it ready in case there’s not much movement from the OECD but, anyway, even if the OECD agrees within the next G7 and G20 meetings on a framework, given the way the processes and how treaties get aligned and legislation passes through, it could be 2025 before everything is in place.

In the interim, the DST is proposed. Now, it could raise at two to three percent of revenue. It could raise maybe $80 mln a year. But, over four or five years, that starts to add up to a substantial amount. $18m is barely 0.1 percent of the government’s tax take at present, but the cumulative effect of the tax means that, over time, it would be worth collecting or certainly worth considering.

Bearing in mind my comments last week about the coming demographic crunch as the taxpayer base gets older but still wants New Zealand super and healthcare and who’s going to pay for all of that? People are obviously looking at the multinationals, but I think that’s going to have to go beyond that, but that’s a topic for another day.

An unexpected slice of pie

The Inland Revenue sprang a surprise on 450,000 taxpayers this week when it revealed that those numbers of people had not applied the correct prescribed investor rate to their KiwiSaver and other portfolio investment entity or PIE caps.

What it was suggesting was that this new system of theirs had picked up these discrepancies – people who should have had a prescribed investor rate or PIR of 28 percent because they were earning above $70,000 but were in fact on a lower prescribed investment rates meant that their KiwiSaver and PIE investments were being undertaxed.

They said, “Well, we’ve got 450,000 people here. They’re going to get a bill for the year to March 2019 for their underpayment.” So far, so good. But then, a couple of days later, that caused considerable consternation as you can quite imagine. I think are over a million KiwiSavers accounts. That’s a lot of people to have got it wrong.

How that’s happened is something that perhaps merits a lot more questions. Investment advisors will say there is a default “do nothing” approach many people take to investment which means that that’s one reason why they underperform long term.

That’s not to say they’re actively trading it out. It’s just that they’re not paying enough attention to realise that their investment performance in their investments is poor. People who have not paid attention to correspondence from their KiwiSaver or PIEs are saying, “Hey, can you confirm that your prescribed investor rate is correct?”

This is unsurprising in that there are people being found out. We have encountered this ourselves from time to time. And so, a quick reminder for everyone, check that you have got the right prescribed investor rate.

The big issue that’s causing concern in the tax community – and, Andrea Black, previous guest and writer of the excellent Let’s Talk About Tax NZ blog has picked up on this in her most recent post – what about prior years?

Now, we do quite a bit in this space. People come to us and say, “Terry, we have got this wrong and we haven’t declared this income. We didn’t realise we had to declare particular types of income.” Foreign superannuation schemes, foreign investment fund regime, and the financial arrangements regime where mortgage rate fluctuations and interest rate foreign exchange fluctuations can be taxed on realised basis.

We often will prepare voluntary disclosures. Generally speaking, we’d file for what we call the open years which are the latest tax year due to be five plus the four previous because those are all within what are called the time bar rules in that Inland Revenue can go back and amend those assessments within that particular period unless there’s evasion or fraud in which case it can go back as far as it likes.

That’s a standard practice. We’ve dealt with a number of clients we do on a regular basis coming through saying, “Oops! File a volunteer disclosure, pay the tax, move on, and that’s it.”

What Inland Revenue has now come out and said is that it is going to collect the tax for the 2018/19 year but it’s not going to follow-up on previous years. Andrea has said, “Is the commissioner really entitled to do that given that Section 6A of the Tax Administration Act says that they have to collect the highest amount of net revenue over time?” Bearing in mind compliance costs, that’s the bit Inland Revenue seemed to miss.

That’s a valid point. What about taxpayers who have voluntarily come forward and said, “Sorry!” and paid up? The Inland Revenue’s actions here have essentially said to that group of people, “Don’t worry about it. Keep your head down and you only have to pay one year – maybe not four years.”

And so, it sets up the revenue in a difficult position for encouraging voluntary compliance which is one of its duties. It’s to preserve Section 6 of the Tax Administration Act 1994 says that its duties are to maintain the integrity of the tax system, including people’s perception of the integrity of the tax system.

Arguably, Inland Revenue, in taking this lenient approach, is in breach of its duties of the law. Take a cynical view, if the boot was on the other foot and it was a taxpayer, would Inland Revenue be so generous?

That’s something I think needs further consideration. I think the Finance and Expenditure Committee and the Minister of Revenue should be asking quietly to get some explanation for the decision behind this and, “Why didn’t you know about this beforehand?”

Inland Revenue’s response to that was almost certainly was that due to the $1.5b business transformation means we could have found it. My answer to that is, “No, you could have done that. You weren’t looking in the first place, but you could be looking.”

I have an instance, for example – and this was something that’s been happening and first observed ten years ago or more – where Inland Revenue was cross-referencing credit card expenditure with taxpayers. If it found that a foreign credit card had been used by a New Zealand resident, it sent along a “please explain, do you have overseas sources of income?”

If you can imagine the work that needs to be done to do that level of forensic accounting and review, then when you’re looking and matching up someone who’s got a prescribed PIE or KiwiSaver with a tax rate is a considerably easier task in my view.

I think Inland Revenue has a bit of explaining to do as to why it wasn’t doing that. It probably ties into my final point we’re going to talk about today that it is feeling the strain with its new business systems and the new transformation phase three of its rollout. There are continual complaints coming through the press about long delays getting through to the call centres.

When you can get through, people are talking about waiting an hour and three-quarters. Even for tax agents like us who have a dedicated line to call, we are finding erratic inconsistencies. Calling at peak times does cause problems, and even though the revenue did add an extra 300 staff to get ready for this, there seems to be a few teething difficulties in this.

In some cases, in my view, this is a bit of an own goal by the Inland Revenue in that it said, “Right. As of this year, everyone is going to do a square-up at the end of the year for anyone on pay as you earn who doesn’t have to file a tax return. You don’t have to use a tax agent. You don’t have to use what’s called personal tax summary intermediaries to sort the tax refund companies. We’ll do it all for you automatically.”

They then said maybe over a million people might be receiving refunds and a significant number of people would be receiving refunds for the first time ever. Now, people hear “tax refund” and think, “I want my money!” even though it could be only $4.00 or $5.00 because of just random differences, so I’m not surprised Inland Revenue has found its systems and its call centre has been all-out because it’s probably set up some unreasonable expectations.

On the other hand, you have to give them kudos for saying, “We can do this.” I’ve always thought this would be a teething period while they sorted it out, so it’s a bit of a bouquet in a brickbat there. Kudos for giving it a go. Maybe they should have toned down people’s expectations on that, but it also doesn’t divert from the fact that they probably may have been kicking a lot of stuff down the road which they should have been dealing with but were waiting such as people on the wrong prescribed investor rate.

Just to put that quickly and come back to that, they say there’s 450,000 people. If the difference between the extra tax payable is just $100 per person, that’s $45m. Again, just to reference back to the digital services tax, the multinationals aren’t going to like the digital services tax. They’re going to complain about that and they’re going to do some lobbying about that. That’s going to happen.

Here, we have government revenue on the one hand – a discussion saying, “We’re going to tax this group of people more. Over here, we have another group of people who are undertaxed but we’re not going to go back and collect the undertax in prior years.”

That’s a recipe there for a lot of strains in the system. I fear that Inland Revenue may be forced to reconsider its rather generous decision to not go back on prior years simply because the politics of the pressure coming on the Minister and other officials are higher up from the likes perhaps of the corporate taxpayers group or certainly Facebook and Google. They will pull out their big lobbying arms for this. They’ll come under pressure and they’ll have to adjust their decision. Just watch this space.

Inland Revenue is feeling the strain

In the meantime, what I would say to people, if you are waiting on a tax refund, be patient. The time will come. You’re not going to move up the queue too quickly even if you did get through to Inland Revenue. That said, there is another matter going on with Inland Revenue which we’ve seen which is that it does seem to be not matching up payments correctly.

It also seems to be ignoring specific instructions we’ve given clients to make. When they make a payment, we say, “Pay this amount for the 2019 tax year,” and the revenue system pulls it across and drops it into an earlier year where it thinks there’s an underpayment.

We had a letter come in; a client was sent a letter for an overdue GST return on the 20th of May, yet the return was filed on the 13th of May. This is the sort of thing I see a lot of here. There’s a lot of teething problems in there, but there’s a lot of friction in the system and a lot of frustration all around the system.

I think things will settle down on that and prepare to cut a bit of slack for Inland Revenue on some of this stuff – not so much on others. I do feel that the whole business transformation project was flawed from the outset in that it did not take enough account of the role the tax agents within the New Zealand tax system.

If we had been involved earlier on – and not just the big four accounting firms but the smaller firms, firms like ourselves which deal with the large corporates – we might have seen a more efficient, user-friendly system. Tax agents are, after all, probably the biggest users of Inland Revenue’s platforms. In my view, we haven’t been given due consideration in the whole business transformation project.

This article is a transcript of the June 7 edition of The Week In Tax, a podcast by Terry Baucher. This transcript is here with permission. You can also listen below.