Covisory Deskside Chat - Latest changes to NZ Tax

The Inland Revenue has recently announced along with the Government proposed changes that will have some impact for you and your businesses.

1. Share Sales
The first proposal is that where you sell shares in a company and the company is flush with retained earnings and imputation credits, part of the share sale consideration will be treated as if it were a dividend. Now this exists already in the dividend stripping provisions which are an anti-avoidance measure in Part G of the Income Tax Act 2007. However, the difference there is the Inland Revenue has got to find the fact that you sold shares flush with retained earnings and that there was an intention to avoid tax by the way of restructure. What is proposed here is that the need for the Inland Revenue to find it will be removed and anyone who is selling shares in a company will ultimately pay tax on those retained earnings because part of the capital gain will be deemed to be the payment of that dividend. Naturally it should follow that imputation credits would flow out, but time will tell.

2. Attribution Rules
The second change that was mooted was to the attribution rules. The attribution rules are there to stop people diverting income that they will earn personally into a company or trust. What that means is that by doing so they can drop the tax rate effectively from 39c to 33c because of course the top marginal rate of 39% applies to income over $180,000 per year. Under current law you require both an interposed entity, ie a company or trust with 80% of the services provided by one individual or associated persons and secondly 80% of those services purchased by one or more related entities.

The proposed change that is mooted is that that second test will drop. For example, a doctor who trades through a company even though he will be seeing lots of patients who pay him small amounts of money that income will have to be paid out under the attribution rules.

We had originally expected this law to apply from 1 April 2022 and there would be little consultation. The good news is that the matter has been referred back to the Select Committee and the law is unlikely to change with effect from 1 April 2022. It is not in the August Tax Bill as we understand it.

3. High Wealth Enquiry
You may be aware that Inland Revenue is investigating rich list New Zealanders to see that they are paying enough tax which they suspect they are not. They are probably right but the reason for this is that most people who are wealthy make capital gains that are tax free under current New Zealand law.

The problem we have is that the rich list enquiry is looking at economic income which includes capital gains and other benefits. As an example, some of the questions that Inland Revenue is asking and information they are seeking from the 400 rich listers is designed to look at benefits they have received by living in expensive homes, getting the use of beach properties etc.

We may see a move not just towards wealth taxes or land taxes but also to some sort of fair dividend rate (FDR) style imputed income from high value houses or beach houses back to individuals which they then have to pay tax on.

Naturally the solution to all of this would be to have a robust capital gains tax brought in that taxed capital gains which is the bulk of the economic income that is going untaxed and secondly to align the trust tax rate of 33c with the current marginal top individual tax rate of 39c.

Now that is what Australia has done for years. New Zealand didn’t do it when we had the last Labour government in the noughties, and it is now creating arbitrage opportunities in the tax system which Inland Revenue is going to have to shut down. The logical thing would have been to make the trust rate 39c with a view to tax capital gains in the future.

4. The Bright-line Test
We had expected the last Tax Act change to include some loosening of the Bright-line Rules. For instance, you had a trust and you wanted to wind it up and transfer say a house or a beach property back to beneficiaries.

We had hoped that Inland Revenue would see sense and enable that transfer to take place without restarting the bright-line period. Sadly, the law that was enacted didn’t do this. It only really applies where you have had an individual who has transferred a property to a trust and now wants to take it back. It is a two-step process if you didn’t transfer it in in the first place you cannot get it out later.

This is an interesting issue because there are a lot of trusts out there that people would like to wind up but the spectre of having your family beach house or properties caught by the now 10-year bright-line period means that there is a reluctance to do that.

Add to that the fact that Inland Revenue does want more information on trusts coming up for the 2022 trust income tax returns there is pressure to wind trusts up. People are not going to have a clear choice of what they are able to do because of the downside of the Bright-line test.

It is an interesting time and much of this could have been avoided by simply tidying up a few matters at a macro level around tax rates and capital gains. Will there be an appetite for taxing capital gains going forward with the spectre of capital losses coming up as well with declining property values and share market prices? We are looking forward to an interesting second half of 2022.