The New Zealand Tax Podcast; Highlights of the International Fiscal Association conference, the new Minister of Revenue introduces himself with good and bad news for taxpayers

The International Fiscal Association (IFA) tax conference is one of the premier tax conferences in the year as it is attended by most of the very senior tax specialists in the country together with senior Inland Revenue officials. Somehow, they also let me in as well.

The primary focus is on tax policy, and the conference is held under Chatham House rules, which means that comments that are made by officials cannot be directly attributed. Notwithstanding this you still get an indication of where officials’ thinking might be heading.

This year’s conference had a particularly interesting agenda covering topics ranging from, the use of trusts, international GST, the treatment of embedded royalties, limited partnerships, to a US perspective on the OECD's international tax agreement process. It concluded with what was probably the highlight of the whole conference ‘What makes a tax good system?’ which we'll discuss later.

Introducing Simon Watts

Traditionally the conference is opened by the Minister of Revenue the Honourable Simon Watts. A qualified paramedic, he had once worked at Inland Revenue as an intern before he moved on to later became a tax consultant with one of the Big Four firms. Coincidentally, the Commissioner of Inland Revenue Peter Mersi was also attending his first IFA conference. It was therefore interesting to see how they interacted, and they both explained to the audience how they felt they were progressing.

The Minister began by reiterating his commitment and that of the Government, to the Generic Tax Policy Process, GTPP, the open consultative process that has been a keystone of New Zealand tax policy for almost 30 years. He was aware that the business community and the tax community had become a little concerned that there was not enough certainty in the tax system as projects were being developed. In particular, he referenced the design of a wealth tax that was undertaken by the last Government but never followed through.

He wants to make sure that there is a strong degree of certainty within the tax system, so he supports the GTPP. Notwithstanding that, there will be times such as around the Budget policy process where the GTPP will be sidelined, and consultation will only begin in earnest when the budget measures are announced.

It's also clear, he's been getting himself up to speed very quickly. He referenced the long-term insights briefing, the Inland Revenue prepared in 2022 on the impact of tax on foreign investment and productivity. He also referenced the regulatory stewardship review of fringe benefit tax (FBT). Following on the Minister’s remarks and comments made by the Commissioner of Inland Revenue, I think we could expect to see more action following up the FBT stewardship review maybe in terms of greater enforcement but also in terms of simplification of the tax and compliance.

The Coalition Government’s is still under development, but the focus will be on tax simplification and reducing compliance costs. That's not unexpected, and from what officials are saying, they're all very heavily invested at the moment in working on those areas and meeting the pressures of the Government’s 100-day programme.

Bright-line test and commercial building depreciation changes confirmed

He confirmed that the bright-line test period will revert to two years with effect from 1st July 2024. From that date sales of bright-line property will not be taxed under the bright-line test, if the property has been held for two or more years. (Other tax rules may still apply). He also confirmed that commercial building depreciation will no longer be available from the start of the 2024-25 tax year.  

The timing of the withdrawal of commercial building depreciation is possibly going to be controversial. The Minister confirmed it would be from the start of the 2024-25 tax year. For most taxpayers, that is 1st April 2024 so it's a future impact. However, for what we call early balance, date payers such as those with a 31st December 2023 balance date their new tax year started on 1st January. Therefore, from that date they can longer claim depreciation on commercial buildings.

That I think is slightly controversial in that there's a retrospective effect to it, obviously, and it may mean some tweaking around provisional tax payments. But the policy has been outlined previously. We'll see the relevant legislation and more detail in due course maybe around the time of the budget policy process announcement towards the end of March.

(Interestingly, the issue of 39% rate for trustees didn't actually come up in discussions with either the Minister of Revenue or the Commissioner of Inland Revenue). Apparently, the Finance Minister’s wish for a 6.5% reduction of costs is still on the table although the effect of this may be counter-balanced by the increased funding for audit activities.

The Minister came across as someone wanting to listen. He also holds the Climate Change portfolio, and he sees quite an overlap with Revenue because they're both seen as financial portfolios. He mentioned that a lot of emphasis is developing in the climate change area around climate finance, which apparently is going to be a focus at this year's COP 29 Conference, which will be held in Azerbaijan.

I had the impression he’s already across a lot of aspects of the portfolio and from comments from the Commissioner and others, he's following up on past Inland Revenue asking if “we've done this, where are we with it? Let's move it forward” which is good to hear.

The uses of trusts – trouble ahead?

Trust specialist Vicki Ammundsen regaled the audience with often hilarious tales of some of more extreme situations she's encountered in her role as a trust lawyer and as a trustee. But amidst all the laughs, a serious point was made time and again: trusts are mostly established and used for non-tax reasons. However, they are not always administered well and in some cases she felt many people had set up trusts for the wrong reasons or completely incorrect reasons and had failed to understand how they would operate.

She also thought there was probably very pretty widespread, if accidental non-compliance with the impact of overseas resident trustees and the treatment of distributions to overseas resident beneficiaries. Her comments echo my own view on what's happening in the trust space. I would also agree with Vicky that we're likely to see more and more trusts wound up as people realise that something that was possibly useful 30 years ago is no longer relevant, and in fact the same objectives can now be achieved by holding assets outside trust.

One point she raised, which I found very relevant in relation to some decisions coming out of the Jersey Tax Court which ruled trustees should not be equalising distributions to beneficiaries to account for asymmetric tax treatment. This may arise when one beneficiary may get a distribution which is tax free in their jurisdiction, but another one has to pay tax on a similar distribution, because they live in a different tax jurisdiction. The Jersey Court’s view is that beneficiaries make a choice to live overseas, and other beneficiaries should not be indirectly affected by that. It’s an interesting point to make because issues around distributions to overseas beneficiary is something that's going to be coming more to the fore in the future. Right now it's an area I'm receiving more enquiries around.

Embedded royalties and the PepsiCo case, an Australian precedent?

“Embedded royalties” might sound strange, but this Australian decision is potentially very significant. To cut a very long story short, PepsiCo the American soft drinks company signed an exclusive bottling agreement with an Australian company Schweppes Australia Pty Limited. Under the agreement Schweppes Australia would make payments for concentrate which it would then turn into soft drinks such as “Pepsi”, “Mountain Dew” and “Gatorade”.

The Australian Tax Office (the ATO), which has always had a reputation for being pretty aggressive in the transfer pricing space, decided to take a case against PepsiCo on the basis that some part of those payments represented an embedded royalty. That portion was therefore subject to the Australian equivalent of non-resident withholding tax even though the payments by Schweppes Australia were actually made to another Australian company, which was a subsidiary of PepsCo. Last November the equivalent of the High Court ruled in favour of the ATO.

It’s a very interesting case, but the key point which emerged in the session was that the overlap between Australian and New Zealand legislation was strong enough that maybe Inland Revenue here might be tempted to take a similar case. (There was another aspect about Australia’s Diverted Profits Tax that's not relevant here). The decision has been appealed and it’s thought likely PepsiCo might choose to settle. But it's interesting to see what happens in Australia because we do tend to watch closely what's happening with the ATO and transfer pricing.  

Tax system oversight – the Australian experience

Speaking of the ATO, one big difference between New Zealand and Australia is that there are more bodies involved in tax oversight of the system in Australia. There's the Australian Board of Taxation and then there is the Inspector General of Taxation, who also is the Tax Ombudsman for Australia.

The current Inspector General of taxation and Taxation Ombudsman for Australia, Karen Payne, presented on how these two bodies were created and what had been the experience so far. This is a particularly interesting topic for myself because I wrote a paper for the last tax working group on the issues around a tax ombudsman.   

She also referenced the American experience with their Taxpayers Advocate Service raising the question whether such an independent office also be an advocate for taxpayers. This could partly resolve the disparity in powers and resources between the tax authority and the ordinary taxpayer. As Karen Payne noted, many of the clients of the partners at the conference are big enough and ugly enough to look after themselves in a dispute. But the general public isn't, so that's a question that comes through when considering the role of a taxpayer Ombudsman/advocate.

Karen Payne also referenced the fact that in certain certain circumstances the Australian Commissioner of Taxation has the power to take some remedial actions, in other words say, “We got this wrong and here’s how we wish to remedy it”. She noted that the Australian Commissioner of Taxation has exercised this power that seven times. On the other hand, even though the Commissioner of Inland Revenue here has a similar power, it's never been exercised. Overall, a very interesting session on what oversight should be in place and the issues involved in setting up that oversight.

International GST, Aotearoa New Zealand leading the way?

On international GST policy, a couple of interesting notes that came out of that one, was that generally speaking in New Zealand has been a world leader in this GST space. We have one of the broadest GSTs in the world which because of much broader reach represents 30% of the total tax revenue. This is above most other countries with GST or Value Added Tax (VAT) system where it generally represents about 20% of the overall tax take.

Around the world, the average VAT/GST rate is 19.2%, whereas ours is lower at 15%. Our GST is a classic example of a very popular topic, the broad based, low rate (BBLR) approach to taxation, where a broader tax makes lower tax rates possible which just about every tax practitioner, including myself, will endorse.

Economics and the environment

We had an economic update from Michael Firth of the New Zealand Superannuation Fund. Several interesting snippets came out of session including that barely 10% of the total funds of the Super Fund are currently invested in New Zealand. Of greater importance when looking ahead to consider the impact of climate change on GDP, the outlook isn’t particularly good. In fact, every forecast seems to make previous ones look over-optimistic even if the best policy response is adopted and we do everything to lower emissions by 2050. The climate change implications around tax policy are how we're going to fund dealing with the physical effects of climate change.

Alternative tax raising options

Michael Firth’s session led into a very interesting presentation from Young IFA about alternative options for raising revenue. The Young IFA presentation referenced the Treasury Briefing to Incoming Minister, which shows that core expenses are rising and unless changes are made, there's going to be a growing and unsustainable deficit, the cost of which will be borne by younger generations, hence their particular interest on the topic.

Young IFA deliberately excluded capital gains tax but looked at three areas, windfall profits and a wealth tax. By OECD measurements our environmental taxes are at the the lower end of the scale, but how you define environmental taxes is elastic so once Road User Charges and Fuel Excise Duties are included, we are nearer to the OECD average.

In any case many environmental taxes are mostly behavioural in that they are levied with the aim of changing behaviour so that less of that particular activity happens. This means so they're not actually long term sustainable because if they work as they should then revenue should decline over time.

Young IFA discussed the suggestion made in 2021 by the Parliamentary Commissioner for the Environment for a departure tax which reflects the environmental cost of flying internationally. Essentially three bands would apply, Australia and the Pacific Islands, Asia and long-haul flights to the US, Europe etc., The Parliamentary Commission for the Environment suggested it could raise about $400 million annually, based on a similar approach taken by UK passenger duty. However, $400 million although welcome still isn't a game changer.

Windfall taxes?

What about a windfall profits tax? These target profits caused by extraordinary events. But they're temporary, retrospective in effect and intended to correct behaviour. They've been used internationally the UK has had a long running bank surcharge to pay for the Global Financial Crisis bailouts.

When Treasury considered a windfall profits tax it estimated a 1.4% surcharge would raise about $230 million per annum rising to close to $700 million based on a 4.2% rate. However, forecasting can go awry when the UK recently introduced a windfall tax on the fossil fuel sector that only raised about 60% of what was expected.

Wealth tax?  No thanks

On wealth taxes it would be fair to say that the audience and to be fair, the Young IFA presenters themselves, were not sold on the idea, because of the complexity, whether it would raise much revenue and concerns about capital flight. The work of Thomas Piketty around wealth taxes is often cited, but as someone from the floor noted he suggests a wealth tax should be applied on a global basis. This would then deal with the question of capital flight. As Young IFA pointed out when Norway recently raised its wealth taxes, there was some capital flight with some rich Norwegians moving overseas in response.  

Although Young IFA and the audience were not sold on the merits of a wealth tax, I think it will still be raised as option because questions about wealth inequality will keep coming up and politicians being politicians see the appeal in an apparently simple solution to the problem.

What makes a good tax system?

The conference ended with a panel discussion on what makes a good system. The panellists were three of the most experienced tax practitioners in the country: Rob McLeod, Robin Oliver and Geof Nightingale. Rob chaired the 2001 McLeod Review, whilst Robin as a Deputy Commissioner at Inland Revenue worked with both the McLeod Review and the 2009-10 Victoria University of Wellington Tax Review before being a member of the Sir Michael Cullen chaired Tax Working Group.  Geof Nightingale was a member of both the Victoria University of Wellington Tax Review and the Cullen Tax Working Group.

As you would expect with such a fantastic panel, it was a very lively session which deserves a whole podcast for itself. We had quotes from Dylan Thomas “Do not go gentle into that cold dark night (of bad tax policy)” and also Hunter S Thompson 'Never turn your back on fear. It should always be in front of you, like a thing that might have to be killed.'

Rob, Robin and Geof expressed varying degrees of confidence in the New Zealand tax system although acknowledging it was under some strain. All three noted the primary purpose of a tax system was to raise money for the government at the lowest practical economic cost.  

There was less unanimity around whether income redistribution really was a key role for a tax system. To some this was a distraction from good tax policy as it leads to distortions but to another panellist it was an inevitable part of modern tax systems. Determining the right level of government expenditure was important, at around 30% of GDP the present system raised sufficient funds but above that level the pressure would mount.

All three were mostly positive that the present system could raise the desired revenue but noted there isn't a lot of low-lying fruit around. Rob McLeod referenced his time working in Australia and the complexities of the capital gains tax. He also mentioned in passing the work done on the Risk-free Rate of Return method as a possible alternative means of taxing housing. Time and again each emphasised the focus should be on keeping the tax policy process and objectives as clear as possible.

Unsurprisingly, all three favoured the BBLR broad-based low-rate approach. They recognised that divergence from this principle is causing strain in the system now. 30 years ago, the company, trustee and top individual tax rates were aligned at 33%. Now this disparity between 28% for a company and Portfolio Investment Entities and 39% for individuals was causing strain. Overall, it was a great ending to an excellent conference all round.

A suggestion for simplifying the tax system and reduce compliance

Moving on, as previously noted, the Minister of Revenue said the Government was committed to simplification. And the limited partners session raised an issue about whether the various withholding tax rules apply to a limited partnership. The policy intent might be that it shouldn't happen, but there's an argument it technically should. Either way some clarification would be useful. (Apparently a draft consultation on various limited partnership tax issues is happening at the moment).

This got me thinking about another area where I think simplification would be helpful, the question of non-resident withholding tax on interest payments made by New Zealand tax residents to an overseas bank in respect of interest payable on an overseas investment property. Those interest payments might be made from a UK bank account to the relevant UK bank lender. However, because they're being made by a New Zealand resident taxpayer to a non resident, the UK bank lender, then non-resident withholding tax should be deducted.  (Worth noting the UK lender’s terms will not accept having tax deducted from the payment which must be grossed up for this purpose).  

Theoretically this is the correct treatment, but it involves an enormous amount of compliance and I think there's also a massive amount of non-compliance because the policy is both unknown and seems counter-intuitive to a lay person.  (It would be fun to see the Commissioner, or some MPs, try explaining to a person they must withhold tax on the interest payment they make from a UK bank account to another UK bank). This is an area where there's a great deal of complexity and I don't think the policy when the withholding tax rules were set up in the late 1980s was intended to catch such situations. (Separately, it’s another area where some thresholds have not been updated for inflation in some time). In summary it’s a ripe area for simplification. Over to you Minister.

What tax tattoo would you get?

And finally, what tax tattoo would you get? This was one of the less serious topics discussed at the IFA Conference and yes, alcohol was involved. For me, the winning suggestion was to tattoo Generic Tax Policy Process on one set of knuckles and BBLR Board Based Low Rate on the other, which puts a rather nice tax spin on Robert Mitchum’s sinister preacher in The Night of the Hunter.

That's all for now. 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.