IRD 'clarifies' its position & hints at targeting tax rate misalignment regardless of election result. Facebook and Google paid more than a billion NZ-collected dollars to offshore affiliates in 2022. And the bills are coming in on climate change

Last week when discussing the new tax bill, which includes the proposal to lift the trust income tax rate to 39%, I mentioned that Example 20 in the accompanying commentary had raised a number of concerns amongst tax agents and advisers. It seemed to be endorsing the option of trusts distributing income to beneficiaries with lower tax rates, leaving us all wondering, is that really correct?

It transpires Inland Revenue picked up on those concerns and then released the following statement.

“We are also aware that one of the examples used in the Bill commentary and factsheet has caused some confusion. The example noted that trustees could distribute income to a beneficiary, who may then decide to resettle it on the trust. We agree that there is some uncertainty under existing law about the tax treatment of such a settlement and we will be undertaking consultation on this. To avoid creating that doubt we have changed the example in those documents.”

The accompanying commentary has been updated and re-released. This shows the area is not as cut and dried as people might imagine. Obviously, Inland Revenue and advisers alike would like to have as much certainty as possible. So, it's good that Inland Revenue picked up on this issue. But you do wonder how it managed to slip into the commentary in the first place without someone realising it might actually be a bit of an issue.

Rate misalignment problem solved? Not quite

Separately another advisor (Aman Chand of Bentleys Chartered Accountants) has picked up an interesting comment in the Regulatory Impact Statements (“RIAs”) which are issued alongside new legislation. RIAs discuss the purpose of this legislation, the alternative options and which one was chosen and why.

The issue the increase in the trustee tax rate to 39% addresses is one of rate misalignment between trustee income being taxed at 33% and individual personal income being taxed at a top rate of 39%. This issue was well understood at the time of the introduction of the reintroduction of the 39% tax rate in 2021. In fact, Inland Revenue and Treasury both said the trustee rate should rise to 39% at the same time. And now that's what's happening.

But for some time, there's also been a rate misalignment between the corporate tax rate of 28%, the portfolio investment entity (“PIE”) rate, which is also 28%, and the then top individual personal rate of 33%. Inland Revenue had been looking at this for some time and had noted that there was starting to be a steady accumulation of undistributed income in companies. This rate misalignment issue was something that had been on its radar which it had started to make moves towards addressing.

What Aman spotted is that the RIA on the increase in the trustee rate does discuss this existing misalignment issue. The RIA notes Ministers have decided to progress increasing the trustee tax rate to 39% “while considering PIE and company shareholder misalignment issues on a longer timeframe”. Even if the trustee tax rate is aligned to the top personal tax rate, there will continue to be opportunities to circumvent that rate by substituting trusts with companies or PIEs. This is something that is going is obviously has been on the Inland Revenue's radar and will remain so.

And even if there's a change of government following the election in October as a result of which the top rate, 39% rate will no longer apply, the issue of a current rate misalignment between 28 and 33%, assuming that remains the top personal tax rate, will remain. Inland Revenue is working on this, and the RIA has some interesting details about potential options.

Don’t be banking on a change of Government

Accordingly, people hanging their hat on a change of government to defer this particular issue of a trustee income tax rate increase to 39% should still be aware that it's likely that Inland Revenue may well introduce or recommend the introduction of other type of tax avoidance rules to tackle rate misalignment in the future. The issue is on their radar, and it still may well be something we will encounter regardless of whoever forms the government after the election.

Facebook, Google and BEPS

Last week I mentioned Facebook. New Zealand had released its results for the year ended 31st December 2022. And coincidentally last week we also covered the Government's proposals for the global anti base erosion rules, the Pillar two proposals which are designed to help tackle the issue of base erosion and profit shifting (BEPS), where the New Zealand tax base is being eroded by profits shifting out of here to lower tax jurisdictions.

Facebook reported gross advertising revenue of over $154 million, but its net profit before tax was $3.3 million. And that's because over $149 million was paid to a related company Meta Platform Ireland Ltd for the purchase of services during the year. Ireland's corporate income tax rate is 12.5%, compared with ours at 28%. Withholding tax may be applied to some of these payments if they are treated as royalties, but you still have an idea of the scale of the issue.

It so happens that last Friday, after we recorded the podcast, Google New Zealand released its results for the year ended 31st December 2022. And in this case, it paid over $870 million in service fees to offshore affiliates. Mostly, it appears to the Singapore based Google Asia Pacific Pte Ltd. You shouldn't be surprised to hear Singapore has a preferential tax regime. Incidentally, MasterCard and Visa New Zealand appear to route their payments through Singapore.

To put everything in context about the scale of the issue being faced by ourselves and other countries, if you look at Facebook and Google New Zealand’s 2022 results they paid more than $1 billion in service fees to overseas affiliates for the year. In theory, at a corporate income tax rate of 28%, that represents over $319 million in potential tax.

So, the Government and other governments are keen to see Pillar Two and Pillar One hopefully come into play and deal with this issue of tax and profit shifting. But as the commentary to the bill which introduced the Pillar Two legislation notes the benefit is likely to be about $40 million annually.

The impact of the GloBE rules is therefore not terribly significant. The issue of profit shifting still remains. It will always be there, by the way, because it is only appropriate that the tech companies charge for the use of their valuable IP in New Zealand. So, it's not a question of we're just going to disallow $1.1 billion of deductions and bingo, we've got $319 million. That is never going to happen.

But the difficulty with transfer pricing is really determining the value on that and just how much of it can be kept in New Zealand. And that's going to be an ongoing struggle, whether or not Pillar One and Pillar Two actually proceed.

Cheque please

Finally, this week the government announced that in the wake of Cyclone Gabrielle, 700 homes around the country are considered unlivable.

And so homeowners will be offered a voluntary buyout through a funding arrangement between the Government and councils. Apparently, another 10,000 homes will require investment in flood mitigation around them so they can be protected when the next severe weather event hits. Note the word “when”, I think we are now in the midst of climate change.

I mention this because it reinforces the point we've been hammering away at for some time. Climate change is here and it’s going to have an impact on homeowners all around the country. It doesn't differentiate between suburbs. The likelihood is that we are going to have to start thinking seriously in some cases about managed retreat, that there will be more and more houses that are unlivable. The insurers are already pricing it in, so some houses may become uninsurable over time.

The question really coming to the forefront now is who's going to pay for this buyout and managed retreat? Councils, for example, may have allowed properties to be built in areas where they should not have been built. Auckland Mayor Wayne Browne has already spoken about this. By the way 400 of those 700 unlivable properties are in the Auckland region.

At a time when next year’s Auckland Council budget is going through a very controversial process, having to fund in some way the buyout of people from 400 properties at a time when the average price house price in Auckland is $1,000,000 is quite a significant hit to the bottom line even if the Government chips in.  

This all reinforces what I've been saying for some time; the impact of climate change plus the demographic changes that are happening with the ageing population means that we really do have to think a lot harder about how much tax we are going to need. Either that, or what services we're going to reduce. And the question of the taxation of capital is going to become ever more important. The politicians keep kicking it down the road, hoping it just will go away. It won't.

The climate change bills are now starting to come in and will continue to mount. We will wait and watch to see who of the politicians in the main parties is going to grasp that nettle and say, “Hey, guys, this is this is the deal. If you want us to help you mitigate the impact of climate change, we have to spread the tax burden wider.”

In the meantime, 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 time, kia pai to rā. Have a great day.