Te wiki o te tāke; The New Zealand Tax Podcast – shots fired in the debate over the true tax burden in New Zealand, and lessons from FATCA

The tax week has been dominated by a report prepared by the Sapere Research Group on the effective tax rates imposed on the income of New Zealand residents.

This report was commissioned by the tax advisory firm OliverShaw and has been released ahead of two reports coming out next week, one from Inland Revenue on the tax and effective economic income of high wealth individuals in New Zealand and the other from Treasury on the effective tax rate of New Zealanders across the income and wealth distributions.

As you may recall, the Inland Revenue project reviewing the net wealth of the 400 richest families in New Zealand has been highly controversial and generated quite a bit of pushback from the outset. There were mutterings about court actions to prevent the proposal going ahead, although as far as I'm aware, none of those have ever eventuated.

Nevertheless, the controversy prompted OliverShaw to commission a report because, as they say in the Foreword of the report:

“From what has been said about the methodology of the Inland Revenue study, it seems that the Inland Revenue and Treasury studies may use different methodologies. A comparison of two different studies using different methodologies could easily produce a misleading and confusing picture of our tax system.

Moreover, the Inland Revenue methodology seems inconsistent with OECD and academic effective tax rate studies….We therefore considered it important to have a study that uses a more consistent approach to estimate the effective tax rates that are imposed on the incomes of low, medium and high wealth households rather than just high wealth individuals.”

That's the rationale that OliverShaw gave for the project. Incidentally the Oliver in OliverShaw, is Robin Oliver, a former Deputy Commissioner of Inland Revenue and a member of the last Tax Working Group. So, he speaks with a lot of authority. You will also recall Oliver was one of three members of the Tax Working Group who produced a dissenting opinion on the proposal for a comprehensive capital gains tax.

Worth keeping in mind, however, that Oliver and the other two dissenters, Kirk Hope and Joanne Hodge did agree with the rest of the group in extending the taxation of residential investment properties. This probably should be kept in mind amongst all controversy the Sapere Research Group report has produced.

The report, to put it mildly, is massive, it runs to a total of 267 pages, in three parts. There's a foreword from OliverShaw, followed by a detailed outline of the report. And finally, the report itself, which breaks down into five sections, an introduction, an overview of New Zealand's tax and benefit systems, the effective tax rates estimates, section four then interprets and applies these effective tax rate estimates. And finally, there is the conclusion in section five.

So it is colossal and to be honest, I haven't yet got my head around all that’s in here. It’s certainly, as I've heard one or two other experts say a report that merits rereading as often is the case when you're processing this much data. As far as I can recall nothing like this was prepared for the Tax Working Group. (No doubt some will correct me if I'm wrong on that).

It's an extensive piece of research and its conclusions are a little controversial, because in essence, they appear to be saying that the average effective tax rate paid by the wealthy is not far off that paid by other middle-income earners.

By the way, the classification of what is middle-income is something that perhaps might provoke some pushback. Low income is seen as under $48,000, which is the threshold at which the income tax rate increases from 17.5% to 30%. Medium-wealth households are described as those that derive annual net real economic incomes between $48,000 and $500,000. High wealth, high income households are those deriving net real economic incomes in excess of $500,000.

That medium-income upper threshold of $500,000 seems pretty high to me. But no doubt the statisticians and others have got a reasonable background on it.

As I said, there's so much in this report to digest that it's possibly the reason why there's a fair bit of confusion about what it is really driving at. In summarizing the report’s conclusions Robin Oliver commented;

“One of the questions asked is whether the very wealthy pay taxes at the same or higher rate than middle income earners…This research shows clearly that, whether you consider taxable income or other measures, such as economic income, the answer is: ‘Yes, they do.’ “

That certainly raised a few eyebrows around the place, including that of Craig Elliffe, another member of the last tax working group. And if you want a good critique of the report and where some of the issues are going to be explored further, The Spinoff has a very good article in which they spoke to Craig Elliffe at length on the matter.

For myself I'm still digesting the report. As I said, it's massive and a significant amount of data to absorb. So, I'm not so keen to rush to judgement. Certainly, that conclusion that Robin Oliver cited surprised me. On the other hand, when he was interviewed for Newstalk ZB, he did point out that there's a real problem with the tax rate jumping from 17.5% to
30%, around the $48,000 threshold.

Indeed, one of the conclusions of the report is arguably the highest effective tax rates are paid by those on the lowest incomes once you take into consideration the impact of abatement of benefits.

Getting your retaliation in first?

The report has generated a lot of controversy, which appears to be the deliberate intention of OliverShaw. It certainly follows the motto adopted by the 1974 Lions captain Willie John McBride when they were about to play the Springboks “Let's get our retaliation in first”.

I'm therefore going to withhold further comment on the report until I've seen the reports from Inland Revenue and Treasury. We’ll then be looking at three very comprehensive reports and I'm sure a clearer picture will emerge as from these reports once they considered as a whole.

Still, it's good to see tax in the news. I think generally we don't talk seriously enough about tax. Politicians will fence around the topic talking in slogans, but the nature of what we tax, and how we tax is incredibly important. As I've said repeatedly in the past, I am concerned that we're facing significant fiscal challenges from climate change and changing demographics. Our tax system has to be seen to be robust enough to meet those demands.

Does that mean, as the economist Cameron Bagrie suggested recently, we may need to be raising taxes? All of that is up for consideration. So, a debate around what's taxed and who pays what is very good to see. And I look forward to engaging more in that debate.

Lessons from FATCA?

Moving on, as noted above, one of the controversies about the Separe report and in general is over the question of the true economic income of the highest net worth New Zealanders. And the controversy really arises because we don't know very much. Data is scarce on this topic and that generally bedevils tax policy and tax revenue authorities around the world and has done for a long period of time.

A report from the United States this week looks at the data obtained as a result of the highly controversial Foreign Account Tax Compliance Act, or FATCA.

 If you recall, this was introduced in the wake of the Global Financial Crisis, and it required banks and financial institutions in overseas jurisdictions to provide data to the United States Internal Revenue Service (“the IRS”), regarding foreign wealth held by United States citizens in those foreign jurisdictions.

To recap, the United States requires all its citizens, whether or not they are living in the United States, to file tax returns. As part of those filings, they are required to provide details of all overseas financial bank accounts. FATCA is an incredibly important piece of legislation, probably one of the most important pieces of tax legislation in the last decade, because it became the genesis of the OECD's Common Reporting Standards on the Automatic Exchange of Information. 

Following the introduction of FATCA. Other jurisdictions thought, “Well, if our financial institutions have to supply this information to the United States, it would be handy if we also knew exactly which of our citizens and tax residents had wealth overseas.” So that was the genesis of the Common Reporting Standards (“the CRS”).

The IRS, together with the United States National Bureau of Economic Research, have just released a report which pulls together all the data so far provided to the IRS since 2015, when FATCA took full effect.

 This has enabled the IRS and therefore the United States government to get a clearer handle on what wealth is held offshore and by whom.

According to the report, around 1.5 million US taxpayers hold foreign financial accounts. The total value of those is around US$4 trillion as of the year ended 31st December 2018.

Just for comparison, the total financial assets of the US households amounted to roughly US$80 trillion in 2022. What is of particular interest to the IRS is about one in seven of these overseas accounts are held in jurisdictions usually considered tax havens such as Switzerland, Luxembourg and the Cayman Islands, but those accounts total nearly US$2 trillion. The report's authors conclude that this indicates accounts in tax havens are, on average, larger.

Another point of interest is the ratio of tax haven assets to GDP is estimated to be about 10%. That was higher than previously estimated. The implication is that financial assets in tax havens may have grown significantly faster than the overall U.S. economy since 2007, which is that baseline for that previous estimated ratio of tax havens wealth to GDP.

The FATCA data is enabling the IRS to get a better idea of who holds overseas assets. It appears that more than 60% of the individuals in the top 0.01% of the income distribution in the United States own foreign accounts, either directly or indirectly. What also happens is that the proportion owning offshore accounts rises as the incomes deciles rises. This apparently ties in with literature, which says that there's a strong correlation between the wealthier a person is, the more wealth is held offshore.

Now this data is prepared for the United States and comes out of FATCA, but I expect Inland Revenue would be mining the data it's receiving through the Common Reporting Standards.

And it might be that we might see some of those findings reflected in next week's reports. It doesn't surprise me, by the way, that the wealthier a person is, the more wealth is likely to be held offshore because wealthier persons will seek to diversify their asset holdings.

That's a natural response and shouldn’t necessarily be seen as being sinister. But whatever the reason, it's interesting to see what the IRS has gathered so far from its data.

And of course, it will be interesting to see how they respond to that data. Of course, they'll certainly get pushback from the Republican Congress on that. But that's politics and taxes, they go hand in hand. I’m curious to see what, if any, reference to CRS data comes out of next week's Treasury and Inland Revenue reports.

New Inland Revenue guidance on the bright-line test and family transactions

And finally, this week, and also connected to our main story, Inland Revenue has released some guidance in relation to the bright-line test and family transactions. Now this particular Interpretation Statement IS 23/02 is very specific.

It applies to the application of the five year bright-line test, that is where the land was purchased between 29th March 2018 when the bright-line test period increased from 2 to 5 years and, 27th March 2021 when the bright-line period was further extended to ten years. As is now usual, the interpretation statement is accompanied by a useful six-page fact sheet.

The Interpretation Statement covers scenarios where parents are assisting children or other close relatives with buying first homes, a partner is added to the title of residential land and where land is inherited under a will which is then on-sold to other beneficiaries.

Generally speaking, if you sell residential land to a family member or partner within the bright-line period, that potentially will trigger a taxable charge. That may also be the case if the land is gifted or sold below market value. On the other hand, if residential land inherited under a will is sold to other beneficiaries under that will, that sale would be exempt from the bright-line test. However, any subsequent sale by those recipients to a third party within the relevant bright-line period would be taxable.

Inland Revenue have promised to release separate guidance on this issue of transactions between family members in relation to the ten-year bright-line period, and that will be considerably more involved.

Something which comes up repeatedly and lies at the heart of the controversy surrounding the Sapere report are the implications of the lack of a comprehensive capital gains tax. At the moment, it results in distortions where someone's economic wealth rises without being subject to tax, whereas in other cases an equivalent rise in value may be taxed because of a different set of circumstances. The various iterations of the bright line test are a good example of this frankly, incoherent approach.

That's all for this week. Next week we'll be looking in detail at the Treasury and Inland Revenue reports on tax and economic incomes of New Zealanders and how their conclusions and methodologies compare with those in the Sapere report.

Until then, I’m Terry Baucher and you can find this podcast on my website or wherever you get your podcasts. Thank you for listening and please send me your feedback and tell your friends and clients. Until next time, kia pai to rā. Have a great day.

*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.