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Richard's November 2020 tax updates
Richard has had over 30 years’ experience with New Zealand and International taxation. His team provide services including:
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Below are articles from Richard’s weekly email ‘A Week in Review’ over the last month. You can sign up for his ‘A Week in Review’ newsletter here and get the updates weekly, directly to your inbox.
- Dot your I’s and cross your T’s, 2 November
- It doesn’t matter what you call it – crooked foreign trusts, 9 November
- Extension to SBCL Scheme, 16 November
- Covid-19 variation No1, 16 November
- Covid-19 variation No2, 16 November
- I can feel it in the wind, 23 November
- Another warning on GST warranties, 23 November
- GST Registrations – winding back the clock, 30 November
- QWBA on negative interest rates, 30 November
- Countdown’s Onecard ruling, 30 November
Dot your I’s and cross your T’s
A recent decision of the High Court, coupled with a case I am presently involved in with IR, is a timely reminder of the need to keep proper accounting records.
The two cases only similarity is that ultimately, the failure to maintain appropriate records may be the downfall of those involved.
In the High Court case, IR’s chasing of $7m plus, including evasion shortfall penalty impositions, is certainly suggestive here that the taxpayer was up to no good, including post IR’s audit commencing, transferring assets out of the company to directors and others closely associated to the company.
IR, on the basis that the company never kept any ledgers, cash books or other such documents that would have allowed its financial position to be determined at any time, applied to the Court to have the company liquidated due to its breach of section 194 of the Companies Act 1993 – the requirement that accounting records must be kept by a company. In this regard, a court can appoint a liquidator in accordance with section 241(4)(b) of the Act, where a board or the company has persistently or seriously failed to comply with the Act.
The High Court agreed with IR’s submissions, and even though the disputes process surrounding the $7m plus assessments was still in play, ordered the appointment of a liquidator so that at least a full examination of the company’s transactions to date, could be undertaken by persons who had a full array of investigative tools provided to them under the Act.
I suspect unfortunately that a failure to maintain adequate records, may also lead to the downfall of a client I am presently acting for, purely in relation to their IR review. The client has a company with significant tax losses brought forward, and unable to utilise the grouping provisions due to the timing of the commencement of the profitable trading entities, the accountant has resorted to (and I’d have to say a relatively common technique used by us all) using management fees as the bread to soak up the gravy of historic losses.
When done properly, there would be a robust argument that a sole director/shareholder of a group of companies could legitimately sit under one company and have his time charged by this company to the other group members. However in this case, it was not hard to see when I first examined what records there were, that numerous dots and crosses were missing, and that the molehill had just become a mountain – why my colleague was perhaps in hindsight, overly eager to pass the file to me (the good old hospital pass).
In terms of records kept to justify the level of management fees charged, there are the financial statements of the payer (the provider entity has numerous outstanding tax returns) reflecting the level of fees paid, and then there is… well, nothing. There are no tax invoices issued by the provider entity documenting the charges, the basis for the calculation of the quantum of the management fees is not documented – in essence the fee basically corresponds to the profit level of the relevant entity, the management fees have been accrued as payables but the charging entity has no bank account (so there is a payment issue), the shareholder has filed his income tax return but with no reference to any salary being paid to him by the loss company (and he has overdrawn current accounts in all of the trading entities), and to cap everything off, the management company has not registered for GST even though the registration threshold has easily been breached (although the paying companies have not claimed the GST on the fees charged – which is still not a good argument as you will appreciate).
So, the battle has only just begun here. We’ve concluded our first three hour meeting with an IR lifer (she’s been with the Revenue since before I started my short stint back in 1987, so she’ll be in no hurry to find a quick resolution) and the client has an appetite to fight (he’s thinking at least two years and probably court, even post my gentle suggestions that he’s up poo creek without a paddle and economics should take precedent over emotions).
A timely reminder therefore, that should you wish to embark on a management fees strategy to assist your client with utilising historic company losses, at least take the time to dot all of your I’s and to cross all of the T’s, taking the proactive approach that you have no doubt that your client will eventually be reviewed by IR, with questions being asked which you should have robust responses for.
And by the way, do not overlook the personal services attribution rules, which is another issue my client may be facing I suspect even if we can get the lifer across the line with the management fees themselves – brought forward losses only able to offset current year personal services income, if the losses were originally incurred in the derivation of personal services income themselves. There was no suggestion by the lifer that she had the issue in mind presently (and she certainly wasn’t short of talking microscopically about anything and everything I can tell you) but watch this space…
It doesn’t matter what you call it – crooked foreign trusts
With another quiet week on the taxation front (new Government settling in, US election, Guy Fawkes??), post some feedback I received from some of you with respect to last week’s management fee discussion and record keeping, this week I thought I would cover off another area of taxation law sometimes overlooked, application of the ordering rules in relation to distributions New Zealand tax residents receive from a foreign trust.
When it comes to considering the New Zealand income tax implications for your client in relation to a distribution they have received from a foreign trust, I trust that everyone will be on the same page, that a distribution by the foreign trustees referenced as having the character as a distribution of beneficiary income is without a doubt assessable income for your client – no different to a distribution of beneficiary income by a New Zealand complying trust to a New Zealand resident beneficiary.
Unlike non-beneficiary income distributions from the New Zealand complying trust which are usually non-assessable in your client’s hands, such distributions from a foreign trust may still be assessable income for your client, if the amount received is deemed to be a taxable distribution.
In this regard, I suspect most of you will be across the definition of a taxable distribution as defined in section HC 15 of the ITA07, essentially being any distribution which is not beneficiary income, trust corpus or realised non-related party capital gains.
Well nothing in that definition to really test our investigative skills you might say, we can simply reach out to the foreign trustees and just have them confirm to us, how they may have characterised the distribution that has been made to our client. Provided the response fits into either the corpus or capital gains categories, then our job is done – correct?
Unfortunately not, due to the existence of section HC 16, introduced to catch all the crooked foreign trustees out there, who simply can’t wait to take advantage of the New Zealand tax system, by simply narrating the distribution as something that it isn’t.
Section HC 16 basically operates to say, “It doesn’t matter what you call it, we are going to treat it this way”.
Arguably draconian in its nature therefore (because it simply ignores the reality of the situation no matter how good the foreign trusts records are), any distribution is considered to be made up of the following elements, in the following order, until each respective element is exhausted (i.e. the total distributions received by your client are in excess of the particular element):
- income derived by the trustee in the current income year;
- income derived by the trustee in an earlier income year;
- a capital gain derived by the trustee in the current income year;
- a capital gain derived by the trustee in an earlier income year; and
- the corpus of the trust
As a consequence of section HC 16, sections HC 15 and HC 16 must therefore be interpreted together.
With respect to this interpretation of the ordering rules, some guidance (although not comprehensive in my view), can be located in IR’s interpretation statements – IS 18/01, ‘Taxation of trusts — income tax’ and IS 19/04, ‘Distributions from foreign trusts’.
As a final note, which comes back to the record keeping aspect, if the records you manage to obtain (if the foreign trustees are helpful which I have found is not always the case) are insufficient to determine the above elements, then all distributions received by your client will simply be treated as taxable distributions.
So good luck and if you get stuck, don’t hesitate to reach out for some assistance.
Extension to SBCL Scheme
The Government has announced the extension of the Small Business Cashflow Loan Scheme for another three years, meaning that applications can now be made up until 31 December 2023.
With the timeframe extension also comes two other notable changes to the scheme:
- If the loan is fully repaid within two years, no interest will be charged (presently one year)
- The use of the loan funds will no longer be restricted to core operating expenditure, extending to the likes of capital expenditure for example.
The other existing features of the scheme remain the same:
- It is for businesses with 50 or fewer full-time-equivalent employees
- They must have been in business on 1 April 2020 and have experienced a 30% decline in revenue as a result of Covid-19 restrictions
- The maximum amount that can be borrowed is $10,000 plus $1,800 per full-time-equivalent employee and only one amount can be drawn down
- The loan period is for five years, no repayments are required for the first two years, and the interest rate is 3% from the date of the loan being provided (unless fully repaid within two years).
Covid-19 variation No1
COV 20/11 – ‘Variation of section 15D(2) of the Goods and Services Tax Act 1985 for applications to change GST taxable period’ has been issued.
The variation is in essence directed towards those registered persons, who due to the impacts of Covid-19 (perhaps the need to obtain refunds sooner) wish to change from a six-monthly filing period to monthly filing periods.
Presently section 15D(2) acts to specify when a change in filing period will take effect, being the end of the taxable period in which the relevant application is made. So, a Mar/Sep filer requesting a change today, will not commence monthly period filing until 1st April 2021.
COV 20/11, which has an application period of 4th November 2020 to 31st March 2021, overrides the present section 15D(2) effective date, to make the change effective from the start of the taxable period in which the change request application is made instead – so our filer would now have their monthly filing periods commencing 1st October 2020.
Covid-19 variation No2
Our second Covid-19 variation for the week, is COV 20/12 – ‘Variation in relation to the definition of ‘finance lease’ in s YA 1 of the Income Tax Act 2007’.
I’m sure you’ve all had the scenario of determining whether your clients new vehicle lease should be defined as an operating lease or a finance lease – the former having the consequence that you simply claim the income tax and GST deductions as you go in respect of each payment made; the latter akin to a vehicle purchase – claim all the GST upfront and then interest costs and depreciation deductions annually.
Assisting with defining the nature of your client’s lease, is the section YA 1 definition, which includes:
finance lease means a lease of a personal property lease asset entered into by a person on or after 20 May 1999 that—
(b) when the person enters the lease or from a later time, involves a term of the lease that is more than 75% of the asset’s estimated useful life as defined in section EE 63 (Meaning of estimated useful life):
In this regard, Covid-19 may have seen lessees impacted by the pandemic, approach their lessors for an extension to the previously agreed lease period. From a tax perspective, this extension could have the consequence of converting an operating lease to a finance lease, due to the extended period of the lease now exceeding the 75% estimated useful life threshold.
To prevent such consequences, COV 20/12 will operate to provide that such leases continue as operating leases, where all of the following conditions are satisfied:
- The lease was entered into before 14 February 2020
- The lease term was not more than 75% of the estimated useful life when the lease was entered into
- The lease term is not extended more than 18 months beyond the end of its term as at 14 February 2020
- The lease was extended because, in the period between January 2020 and 31 March 2021, the lessee’s business has experienced a significant decline in actual or predicted revenue which means the lessee had difficulty satisfying their existing lease agreement, and that decline in actual or predicted revenue is related to Covid-19.
COV 20/12 applies for the period 5th November 2020 to 31st March 2021.
I can feel it in the wind
A few weeks back I shared my views on Labour’s election win, the likely introduction of a 39% top marginal tax rate, and the potential to see a greater focus by IR on the application of the personal services application rules.
Well lo and behold, IR have suddenly released draft interpretation statement PUB00321 ‘Income tax – Calculating income from personal services to be attributed to the working person’. At first glance, my immediate reaction would be “here we go, IR’s starting to lay the foundations”, however sucking in a few big ones and returning to my more usual calm, logical state, I suspect a look back through IR’s work programme agenda earlier in the year, would reveal that the item has been planned for a release for some time.
Now the first thing to note about PUB00321, is that it is not a comprehensive discussion by IR on the attribution rules as a whole – that detail can be sourced from the 2019 release of IR 19/02 ‘Income Tax – Attribution rule for income from personal services’. Instead, this item focusses on how one should calculate the income that needs to be attributed to the working person (as provided for in section GB 29).
- The document is 45 pages in length, and contains commentary on:
- The general attribution rule calculation ‘the lowest of three amounts’
- Key issues to consider when computing ‘the lowest of three amounts’
- Certain things specifically taken into account and not taken into account in the calculations
- The extent to which the look-through status of LTC’s and partnerships is ignored
- The treatment of dividends, both in-year and post-year
- The implications for foreign tax credits attached to foreign personal services income derived
Like any good interpretation statement issued by IR, there are a myriad of examples throughout the commentary to explain the narrative.
If you would like to have your say on draft PUB00321, the deadline for commentary is Christmas Eve – and isn’t that approaching way too quickly!
Another warning on GST warranties
I read an interesting case decision of the High Court during the week, which is certainly a timely reminder again about ensuring our clients take due care when completing their sale and purchase agreements (or more likely, a real estate agent is completing on their behalf!).
What struck me about this recent decision, was that on all accounts the purchaser has suffered no actual economic loss, yet the Court still found against the vendor and awarded damages.
So what happened in a nutshell – well for whatever logical reason the vendor had in her head, the agreement for sale and purchase reflected that she was not registered for GST for the purpose of this transaction, when in fact she was – the property contained a house, shop, workshop and on-site parking. Now admittedly I have not reverted back to the District Court decision to try to understand why the vendor thought the property was not in the GST net (she was still GST registered after all when entering into the agreement, but perhaps her view was that this property was no longer used in whatever taxable activities she was carrying on at the time).
The purchasers entered into the agreement thinking they would use the existing structures upon the land to operate a lamp manufacturing and sale business and a toy museum, and were therefore planning to claim a GST second-hand goods input tax claim to fund working capital for the business.
Now no problem with the decision of the Court at this point, however the purchaser, based on professional advice received, decided not to proceed with the business as intended, and instead subdivided the land and sold the shop with its road frontage (and not as part of a GST taxable activity carried on as the purchaser did not in fact proceed to register for GST).
So at this point you would be thinking, well that’s ok, everybody’s happy, however somebody clearly whispered in the purchasers ear that because the vendor had breached her warranty with respect to her stated GST registration status (apparently not discovered until post the decision being made not to proceed with the intended business activities), the purchasers had lost their contracted anticipation of being able to obtain a GST refund and consequently they should sue – which they did – and they won!
Here’s the reason for the decision, however you may wish to read the cases in full to get your head around it (Marr v Mills (2020) NZHC 3004):
- The District Court did not err. As a prospective benefit was denied the Mills by Ms Marr’s breach of warranty, the GST refund was sufficiently foreseeable to warrant its award in damages.
- The value to the Mills of the loss of Ms Marr’s promised performance was the GST refund to provide start-up working capital for the businesses. The allocation of risk by the GST warranty meant such was within the contemplation of the parties at the time of the property’s acquisition. That was the financial position the Mills were denied by Ms Marr’s breach of the warranty.
- The Mills’ post-auction instruction of the property’s apportioned valuation for GST purposes was given in advance of notice of Ms Marr’s breached warranty. The instruction was not opportunistic on the Mills knowing of the breach.
GST Registrations – winding back the clock
I remember in the ‘old’ days, when you used to be able to file your application for GST registration, with IR accepting any effective date requested, although they would sometimes get a little touchy if the date was more than six months old.
Those memories are fast disappearing however, particularly since the 2018 release of SPS 18/03, and the common practice nowadays, that regardless of what effective date you request, IR uses the date the application is filed, and it is like trying to pull teeth to get a backdated approval.
A recent case I had, an overseas client should have registered in October 2019, as their invoices from day one, reflected GST being charged on the services supplied. The application was referred to the customer compliance team, and I was informed in no uncertain terms, that unless I could produce evidence of the obligation for the client to be registered some 12 months ago, my request for backdating would be denied. Luckily this time around, proving the requisite obligation was simple, as I already had access to the client’s Xero file, so I could provide the Revenue with copies of the first tax invoices issued, reflecting the GST charged.
Much harder scenarios to overcome however, are those related to property developments, particularly where an existing residential dwelling is acquired, with plans to demolish and put four houses on the same footprint. Clearly the sale of any one title within the coming 12 months would exceed the compulsory registration threshold and consequently dictate the obligation to register for GST now (plus the client wants their second-hand goods claim yesterday).
Once again, reminiscing on the days of old, a statement of the client’s intentions to develop the land and sell within 12 months, was sufficient to have the Revenue sign off on a backdated registration date. These days however, you need to provide fully detailed business plans, plus the kitchen sink at a minimum, to prove that your client had an obligation to register on the date requested, and that it is not a voluntary registration scenario – which the Revenue’s SPS 18/03 stresses will see the date of the registration application being used, unless there are ‘exceptional circumstances’ as to why your client is late in registering.
To remind taxpayers of the SPS 18/03 commentary, IR updated their website on the 23rd November, to confirm that ‘The start date of a GST registration is usually the date the application is made.’ So if you have a client come to you, requesting a backdated registration date to enable them to recover some costs already incurred, it would be prudent to put them on notice of IR’s present stance, and that they may just have to wear the GST charged on those initial costs (or perhaps recover them more slowly via the annual adjustment period claims process).
QWBA on negative interest rates
One of the many consequences of Covid-19, is the potential for banks and other financial institutions to have a scenario where negative interest rates apply to an advance of money or a loan – the bank or financial institution will actually pay you interest in return for you borrowing from them.
Gearing up for this potential unprecedented event, questions have been asked as to whether the payer of the negative interest will have either RWT or NRWT withholding obligations at the time of making the interest payments to the borrower.
IR has responded with draft ADV000097 – Whether ‘negative interest’ payments are subject to withholding taxes.
The draft QWBA suggests that the correct answer to the question is no – the payments will not be subject to withholding taxes. This is because the RWT and NRWT rules only apply to payments made by a person to another person in respect to money lent. However with a negative interest rate scenario, it cannot truly be said that the interest is paid for money lent – if it was paid for money lent, then it would be in return for the money lent, and paying interest to the person who has received the loan funds, is not a return to the lender on the loan funds advanced.
If you wish to have your say on ADV000097, the deadline for comment is 15th January 2021.
Countdown’s Onecard Ruling
Countdown has recently applied for a product ruling from IR, with respect to its Onecard donate to charity programme.
For those of you who shop at Countdown and use your Onecard each time you make a purchase, you will appreciate that you accumulate Onecard points based on your dollar spend, and every now and then you’re receive a message that your points total has now crossed the threshold to generate an e-voucher, which if you’re like me, you immediately use to offset against your current shopping tally.
Well apparently, rather than spending this e-voucher on yourself, you can also request that Countdown donate your e-voucher monetary value to one of a number of charities who participate in the programme.
The product ruling has been sought, to clarify whether the Onecard holder is then entitled to claim a donation rebate, which respect to the value of the e-voucher donated to the participating charity.
In a nutshell, provided the six conditions stipulated by the Commissioner are satisfied (nothing earth-shattering or unexpected), a Onecard holder’s donation of $5 or more, will be deemed for the purpose of sections LD 1 and LD 3 to be ‘a charitable or other public benefit gift’.
Consequently, the Onecard holder will have under section LD 1(2), a tax credit, for the tax year in which the ‘charitable or other public benefit gift’ is paid, equal to the amount of the e-voucher donated multiplied by 33 & 1/3%.
The Ruling applies for the period 25th November 2020 to 31st December 2023.
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