The New Zealand Tax Podcast – The Minister of Finance hints at review of charitable tax exemption; Inland Revenue targets smaller liquor outlets; How effective marginal tax rates act as disincentives

Last week was Scrutiny Week at Parliament. This is a new initiative where the select committees get to grill ministers for longer than normally would be the case. In total, there were over 134 hours of hearings across all the select committees.

(Minister of Revenue Simon Watts flanked by Inland Revenue officials during his appearance before the Finance & Expenditure Committee)

The Minister of Finance, Nicola Willis, and the Minister of Revenue, Simon Watts, were both in front of the Finance and Expenditure Committee and it made for some interesting hearing.

 A large part of the inquiries directed at the Minister of Finance focused on the Budget and spending choices made or not made, particularly in relation to funding of cancer drugs.

Inland Revenue to review Charity Sector?

The Minister of Finance Nicola Willis was also quizzed on general tax policy and in the course of that she dropped a big hint about a sector of the economy which is going to come under inquiry. In response to a question on tax policy she commented

“We will put together a tax policy programme that looks at other issues. In particular, I have previously identified that we have some concerns around whether all charities are effectively meeting the expectations that we have [regarding] genuinely charitable activity. We don't want to see [concessionary tax rates] being exploited for activities, which are more clearly more commercial in nature.”

This is a clear shot across the bow of the Charity Sector, although the Minister has foreshadowed this before. It’s now apparent Inland Revenue will undertake an in-depth review of the sector.

Boosting Inland Revenue’s investigation capability

The Revenue Minister Simon Watts faced more detailed scrutiny over the operation of his portfolio. He confirmed that one of the Budget initiatives provided funding which would enable Inland Revenue to take on a further 200 full time employees. These additional staff would be directed to improve Inland Revenue’s compliance and investigation activities. This group will be expected to return $8 for every dollar spent on investigation and compliance activity. As the government has allocated $116 million over the next four years to this initiative that means it could reasonably expect to see a return of close to a billion dollars.

When he was questioned about a potential structural deficit and how the government might respond to that, he made it clear that there were no intentions at this stage of introducing new any new taxes. This is what you would expect to hear from the current coalition Government. Clearly the intention is that extra funds will be found by more efficient administration and boosting Inland Revenue’s compliance activities.

Inland Revenue checks out smaller liquor outlets

By coincidence, this week, Inland Revenue announced some insights from a hidden economy campaign which it had run focusing on smaller liquor outlets throughout the country. According to Inland Revenue the number of off-licence liquor stores has grown quite rapidly since 2020 and now there are nearly 3,000 throughout the country.

In 2020, the total sales of these outlets amounted to $1.95 billion with taxable profits of 34.7 million and income tax paid of $11.41 million with a further $29.4 million of net GST collected.

In the first stage of this campaign Inland Revenue compliance staff made 220 unannounced visits looking for signs of issues such as income suppression, unreported sales and non-registered staff. There’s nothing dramatic about what Inland Revenue do here. Their practice is to wander in quietly and have a look around a store. They may or may not buy anything, but they will certainly watch to see what happens behind the till. This is a long-standing technique that it has used for decades across many businesses and it's highly successful. The truth is when you put boots on the ground with investigations, you get results.

What Inland Revenue found

During these visits, Inland Revenue found more than 100 employees had had PAYE deducted from their wages, but not then paid on to Inland Revenue. Inland Revenue also found issues around migrant exploitation issues with wages paid under the table and use of family labour who are not registered workers. They also found high levels of unreported cash and poor record keeping. In addition, “there was evidence of poor employee relations” None of this is particularly surprising to me as I have encountered similar issues.

Inland Revenue made 220 visits and as a result, 9 outlets have been referred for audit. That's nearly 5% of all of those that were reviewed. It's quite likely Inland Revenue already had suspicions about some of these outlets which is why they got chosen for an on-site visit in the first place.

There were a couple of other interesting points of note. Inland Revenue found that companies with multiple family members and changes of ownership demonstrated “less clear money trails”, and some directors appeared to be in name only with minimal knowledge of the business or their director responsibilities. By the way with such shadow, or nominal directors, if in fact someone is behind the scenes pulling all the strings that person can be treated as the director for company law purposes.

What next?

Inland Revenue said this was a “deliberate light touch campaign” and therefore only the beginning, obviously, of a wider look into smaller liquor stores nationwide. Clearly if you've just done a “light touch” review and you've basically found close to 5% of businesses are worth auditing it’s easy to imagine there's scope for much greater investigation work if a more detailed and less light-handed approach is taken.

We will watch this space to see what further developments we hear from Inland Revenue.  Clearly, as both the Minister of Finance and Minister of Revenue both noted in in their appearances before the Finance and Expenditure Committee, this is an area where they're happy to give Inland Revenue more funding with the expectation that they Inland Revenue will deliver significant returns.

What about them EMTRs?

Returning to our discussion last week about high effective marginal tax rates (EMTRs) and the shocking realisation that unless something is done soon, some people on the family minimum family tax credit will be facing effective marginal tax rate of 128.6% or even more, this story got picked up by RNZ and was then circulated quite widely.  This issue was raised by the Finance and Expenditure Committee, with both the Minister of Finance and the Minister of Revenue. Simon Watts, the Minister of Revenue, acknowledged that there was an issue and he had sought information from Inland Revenue on what options were available to address it. The Minister of Finance was rather more pugnacious when quizzed about the issue. Instead, she was happier to focus on the fact that only a small group of people were affected and made no particular commitment to addressing the matter.

EMTRs and the UK election

Now it so happens that effective marginal tax rates have become a bit of a political issue in the UK general election campaign. Parties are releasing their manifestos and as a result there's been some interesting commentary emerge about the impact of high effective marginal tax rates as a result of some of the proposed policies. What stands out over there is, as here, there is a general widespread lack of knowledge about how effective marginal tax rates operate and how high they can be.

What’s sparked the debate is what happens with child benefit, the equivalent of Working for Families. There is a High-Income Child Benefit Charge which starts clawing back Child Benefit when income exceeds £60,200. The charge means for people earning above that threshold and up to about £80,000, their effective marginal tax rate jumps from 42% to 56.5%. And some of the proposals made by parties would push it even higher to over 70%.

Dan Neidle of Tax Policy Associates wrote a very interesting and informative blog post on the whole matter explaining how EMTRs operate.

Dan also referred to a very useful paper from the Tax Foundation which highlighted that these issues around EMTRs are quite common internationally.

The disincentive effect of EMTRs

Where this is relevant for all of us here is the disincentive effect of high EMTRs. What is emerging as another particular EMTR problem in the UK is there's another threshold that kicks in at £100,000 which also triggers some very high EMTRs. As Dan Neidle noted:

“We’ve received many reports saying that high marginal rates affecting senior doctors/consultants are an important factor in the NHS’s current staffing problems – exacerbated by the fact that the starting salary for a full time consultant is just under £100,000.”

The normal marginal tax rate for someone earning £100,000 in the UK is 42%. But above that threshold there's an income bracket where the EMTR jumps to 62% and in some circumstances even higher, before the EMTR settles down around the £150,000 mark. The state of the National Health Service (NHS) is a major election issue so if high EMTRs are acting as a disincentive to recruiting NHS that is something voters will want addressed.

The New Zealand conundrum - high EMTRs on below average incomes

As I said last week EMTRs are a feature of every tax system. What I think is interesting when you look at the UK debate over EMTRs is there’s a big difference in the level of income under discussion. £60,000 in the UK is well above the average salary in the UK and the standard marginal tax rate for people on that income is 42%. (40% income tax plus 2% National Insurance Contributions).

However, here we're looking at EMTRs of at least 45.1% (17.5% tax plus 1.6% ACC plus 27% Working for Families clawback) kicking in at a very low level – just $42,700. That threshold is currently below what someone on the minimum wage of $23.15 per hour working 40 hours a week would earn. Our problem here is not that we have high effective marginal tax rates, that's a common issue around the world, it is that we have people on very modest levels of income suffering those high effective marginal tax rates. And, just as in the UK, it acts as a disincentive. After last week’s podcast I had some correspondence from a relative who as a young solo mother explained that she often found it wasn't worth her while to take additional work because of the impact of the abatement of Working for Family credits. Often 50% or more of her additional income would be lost.

Over to you politicians

This is not a new issue and from my perspective I find it rather frustrating to see to hear the Minister of Finance be very dismissive when quizzed on the topic. She does not appear to acknowledge that this is a major issue which needs to be addressed. Perhaps she's looking at it through an entirely political lens and does not want to acknowledge the other side has a point. As I always say, tax is politics.

But the question about high effective marginal tax rates and the abatement thresholds around Working for Families is a multi-government multiparty failure. The present situation is the result of decisions taken by governments since 2009. So that involves both Labour led and National led governments.

To me this is one of those scenarios where it would be good to put the politics aside and focus on actually trying to fix the problem. The two issues around that are ‘Have we made the interaction between tax and benefits too complicated?’ and ‘What are we going to do about the abatement threshold? Are we going to let it linger or are we going to return to having it indexed regularly?’ The Minister of Revenue was noncommittal on that point and as I said, the Minister of Finance wasn't prepared to discuss the point either.

I would hope that there's common ground here for all the parties to try and find a more rational approach to this by focusing on the fact that if we want to get people into work, improve their lives, we need to remove the tax incentives that happen to prevent them from doing so. Fingers crossed we'll see some movement on this issue in due course.

Well, that's all for this week, 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.