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Richard’s Tax Updates: Oct/Nov
Richard has had over 25 years’ experience with NZ taxation, and particularly enjoys dealing with land tax issues and the GST regime. He deals with clients of all types and sizes and provides tax opinions on the appropriate treatment of items of income and expenditure, assists clients with IRD risk reviews and audits and can assist clients who are having difficulties meeting their tax payment obligations to make suitable repayment arrangements with the IRD.
Here are snippets from Richard’s weekly email ‘A Week in Review’…
- Diverting Personal Income
- Use of Electronic Signatures
- Section 113 Use Clarified
- Farmhouse Expenditure Deductibility
- IRD Focus on Construction Industry
- Using Tax Losses to Pay Shortfall Penalties
- Lump Sum Settlement Payments
- More Time for Hybrid Mismatch Arrangement Submissions
- Claiming Foreign Tax Credits
- Making PAYE Administration Simpler
- Retrospective Adjustments to Shareholder Salaries
- Tax Policy Work Programme Update
- Detailed Seismic Assessment Costs
- Foster Care Payments
- Trust Law Proposed Amendments Released
- The Stats Are Out…
- Minister’s Address to CAANZ Conference
- Greater Sharing with MSD
- Bloodstock Breeding – What If You Race First?
Diverting Personal Income
The recent TRA decision in Case 11/2016 will be a timely reminder to tax agents and their clients, that the Court will support a reconstruction by the Commissioner under the various anti avoidance provisions of the Income Tax Act legislation, where there is any attempt to divert personal income (or re-characterise the income as being something else) to associated entities.
In the present case, the taxpayer had used management fees (charged by various trusts, but the taxpayer still enjoyed the benefit of) and loans as effectively income substitutes.
While the personal services attribution rules effectively dealt with the trust diversion aspect (apparently overlooked by the taxpayer and therefore conceded without argument), the judgement should be noted for its comments that it was commercially unrealistic that the taxpayer would have provided his services to the trust(s) without receiving a market salary in respect of those services (distinct from a company scenario where a shareholder can effectively provide services unremunerated) and consequently the tax avoidance purpose was more than merely incidental to any other purpose or effect of the arrangement.
Equally the Court felt the loan arrangement lacked any commercial reality, while the tax benefits of the arrangement were significant. Consequently the various provisions of the income tax legislation had been used by the taxpayer in a way not contemplated by Parliament and the reconstruction by the Commissioner was clearly appropriate in the circumstances.
Use of Electronic Signatures
IR has confirmed it will accept the use of electronic signatures with respect to documents and information provided to it in certain circumstances. Further information can be found in the “Statement for the use of a valid electronic signature on documents provided to the Commissioner” on IR’s website but in essence IR will accept an electronic signature on all documents and information that currently require a conventional signature, where this option is specified in the relevant document or associated guidelines.
Section 113 use clarified
A recent Court of Appeal decision has discussed important issues concerning the role of s 113 and the obligations of the Commissioner under it, and the extent to which the Commissioner’s decisions may be subject to judicial review (Charter Holdings Limited v C of IR  NZCA 499). Many of you will be aware that section 113 requests are the common mechanism to use to adjust your client’s previous assessments where the four month NOPA period has expired, however it is completely at the Commissioners discretion as to whether or not to accept a section 113 adjustment request.
In short, this is a case surrounding what seems to have been an innocent error made by a taxpayer preparing his company’s tax return, perhaps not helped by various delays in attending to his filing obligations. In a number of earlier income years, the company had incurred tax losses, however when tax returns were completed, box 25 was left blank, as there was no income for the particular year to be offset by the losses brought forward and the assumption was made that the Commissioner already had a record of the prior year losses. It was not until income was actually earned in subsequent income years therefore and assessments for income tax payable and penalties charged were issued, that the taxpayer became aware of his mistake.
Interestingly, the IR case manager the taxpayer was dealing with, recommended in her report to her team leader, that the section 113 adjustment request be accepted. However the team leader (perhaps wanting to take a “higher ground” approach and penalise the taxpayer for his tardiness) declined the request on the basis of “lack of information”.
The taxpayer applied for judicial review in the High Court, however lost on the basis that, (a) the company had been in a position to invoke the statutory disputes process (however note that the team leaders decision was not advised until post the expiry of the relevant period) in respect of the assessments in question, (b) had failed to do so, and (c) could not, therefore, use the judicial review process to dispute the quantification of its tax liability for the relevant income tax years. This was said to be the result compelled by s 109 of the TAA as interpreted by the Supreme Court in Tannadyce Investments Ltd v Commissioner of Inland Revenue  2 NZLR 153.
The taxpayer appealed to the Court of Appeal, who overruled the High Court decision, stating that the lower Court erred when it held that judicial review of a decision under s 113 must be refused except when the statutory process could never be invoked. Instead, section 113 was intended to stand outside of and be supplementary to the disputes and challenge process provided for in the Tax Administration Act (“TAA”). It allows the Commissioner to amend an assessment at any stage when she thinks it necessary to ensure its correctness. Amendment of an assessment so as to ensure its correctness was clearly in accordance with protecting the integrity of the tax system in terms of s 6(2) of the TAA.
In this instance, insofar as additional information was necessary in order to make a proper decision under section 113, it should had been requested, particularly where the Commissioner had actually engaged with the taxpayer in a process leading to consideration of the exercise of the section 113 power. This was especially so since the IR case manager had evidently considered she had sufficient information for the purposes of her report.
Farmhouse Expenditure Deductibility
IR has released draft interpretation statement QWB00082: “Income tax — deductibility of farmhouse expenses” for consultation.
The IS is the result of a review of long-standing concessions for the farming industry which had previously permitted a flat 25% deduction for farmhouse expenses without any evidence, as well as 100% deductions for interest and rates. These concessions are withdrawn under the IS and instead replaced with the requirement that deductions for farmhouse expenses are available only to the extent that they are incurred in carrying on the farming business. The main consequence of the change of IR’s position, is that sole traders and partners of partnerships can only claim deductions based on the actual business use of the farmhouse.
However, a limited concession will still apply where the cost of the farmhouse is 20% or less than the total cost of the farm, to permit a claim for an automatic 15% deduction (believed to be a more realistic amount) for farmhouse expenses and 100% deductions for interest.
Taxpayers unable to apply the limited concession, may be able to utilise the proposed square metre rate method included in the Taxation (Business Tax, Exchange of Information, and Remedial Matters) Bill presently before Parliament, to determine the amount of a deduction for a building that is used partly for business and partly for other purposes.
Any changes will apply from the start of the 2017–18 year.
IRD Focus on Construction Industry
For those of you who did not receive the recent update from IR, a current focus is with respect to undeclared cash in the construction sector, and IR will be writing to certain taxpayers in that regard (which may be some of your clients and result in a subsequent call for advice). The IR correspondence will essentially be a reminder of the obligation to declare all income, including cash jobs – no matter how big or small – when your client files their GST and/or income tax returns.
The IR update also reminds you, as your client’s tax agent, of the important role you have in ensuring your clients get their tax positions right.
Using Tax Losses to Pay Shortfall Penalties
IR has released SPS 16/04 which applies from 1st November 2016 and replaces SPS INV-245. The statement addresses the ability of your clients to utilise tax losses to pay shortfall penalties that may have been imposed on them as a result of a recent IR review and consequent reassessment action.
The relevant legislative provision is contained in section IW 1 of the Income Tax Act 2007. The option only applies to an income tax liability and notification must be provided to the Commissioner no later than the due date for the payment of the shortfall penalty. Your client must have a tax loss available for the relevant tax year (includes a loss brought forward), which is the tax year during which the shortfall penalty is imposed. The offset rate for an individual is the lowest marginal tax rate for the tax year the shortfall penalty relates to (most likely 10.5%). For other taxpayers, the offset rate is the tax rate which would apply if the entity had tax to pay in the tax year the shortfall penalty is for (most likely 28% for a company and 33% for a trust).
Part payment of the shortfall penalty by way of loss offset is permitted, with any balance being paid by way of usual payment methods.
Lump Sum Settlement Payments
IR has released IS 16/04 which expresses its position with respect to the income tax treatment of lump sum settlement payments, particularly where elements of receipts of both a capital and revenue nature are involved.
Of primary consideration is determining what has been given up in return for the payment, and once that is established, whether apportionment is then required to split the receipt into capital and revenue components. IR’s view is that NZ courts would seek a reasonable basis for apportioning a lump sum and that such apportionment should be made on an objective basis. The starting point for any analysis in this regard, should be the settlement agreement itself and any related documents, particularly a statement of claim (if there is one).
The onus of proof is on the taxpayer to show the apportionment basis adopted is reasonable. IR’s view is that there will only be rare cases where apportionment cannot be determined, however where that does occur, the whole amount should be treated the same. Should a payment include an element that would be taxable under Part C of the Income Tax Act 2007, then the burden is on the taxpayer to prove what amount should not be taxable and to the extent that cannot be done, IR will treat the full amount as being assessable.
With IR’s position in mind, if you are aware of your client being involved in potential settlement negotiations, particularly if they are to be on the receiving end, it would be worthwhile mentioning the evidence that may be required to support a subsequent capital receipt claim (although not always easy to negotiate the paying party putting anything specific in writing, particularly where they are taking a “no fault/admission of liability” position). As a final note in this regard, IR does state they may apply their own apportionment basis where they suspect the capital element is excessive or the agreement is a sham or part of a tax avoidance arrangement.
More Time for Hybrid Mismatch Arrangement Submissions
For those of you interested in making a submission with respect to the OECD recommendations on targeting the deliberate exploitation of hybrid mismatches by MNE’s, IR has extended the filing deadline from 28th October to 11th November.
Claiming Foreign Tax Credits
IR has recently issued IS 16/05, which deals with the issue of how to claim a foreign tax credit where the foreign tax paid is covered by a double tax agreement (“DTA”). Should the foreign tax paid not be covered by a DTA, then any entitlement to claim will be determined by the provisions of subpart LJ of the Income Tax Act 2007. In this regard, reference can be made to IR’s previously released IS 14/02.
IS 16/05 contains, as IR refers to it, a flowchart that is a useful framework for analysing a foreign tax credit issue. In essence it’s a three-step approach – is the foreign tax paid in relation to a tax covered by the relevant DTA, if so, is the person (including persons other than individuals) resident in NZ for the purpose of the DTA, and finally if so, which State has been allocated the taxing rights with respect to the foreign income (including capital gains) on which the foreign tax has been paid. With respect to this last test, either NZ or the foreign State may have been allocated an exclusive taxing right under the DTA or the foreign State may have an unlimited/limited taxing right while NZ retains an unlimited taxing right (due to residency of the person).
A classic example of this last point that many of you might have experienced with your own clients in recent times, is the UK pension scenario. The NZ/UK DTA pension article provides an exclusive taxing right to the State in which the pension recipient is resident. UK residents were migrating to NZ however their UK pension providers were either unaware of the move or of the exclusive taxing right given to NZ, once the person had moved here. Historically we used to simply file our client’s income tax return and claim a foreign tax credit against the NZ tax payable on the pension – no problem. However eventually IR cottoned on to the fact it had the exclusive taxing right over the income and consequently commenced denying any foreign tax credit claims made, advising taxpayers instead that they had to seek redress for the over-taxation, directly either from their UK pension provider or the UK Inland Revenue.
IS 16/05 also provides some useful commentary with respect to how to interpret and apply DTA’s in general, so certainly a useful read in my opinion even for those of you not directly considering the foreign tax credit claim issue but who have DTA application issues on occasion to consider.
Making PAYE Administration Simpler
Following on from their November 2015 discussion document, IR has released early information about proposals likely to be included in a 2017 tax Bill to simplify the administration of PAYE for employers. The changes include removing the requirement of employers to file the employer monthly schedule – instead filing PAYE information on a payday basis from 1 April 2019; enabling employers using payroll software to file directly from their payroll system; reducing the electronic filing threshold from the present $100,000 PAYE/ESCT to $50,000; and, ceasing the existing payroll subsidy provided to employers who outsource their PAYE obligations to listed payroll intermediaries from 1 April 2018.
There are no proposed change to the present due dates for PAYE and related deductions, however there will be an option for employers to make these payments on the relevant payday instead if they choose to.
Retrospective Adjustments to Shareholder Salaries
Essentially a replacement of SPS 05/05, draft ED0190 was released by IR for comment on 3rd November. Its release follows on from the earlier release of SPS 16/01, which sets out in detail, the process that the Commissioner will use to consider section 113 requests. Referring to SPS 16/01, ED0190 sets out the criteria for considering whether the circumstances are appropriate for the Commissioner to agree to retrospectively alter an amount of shareholder’s salary. The statement considers requests to either increase or decrease an amount of a shareholder’s salary.
Applying SPS 16/01, the Commissioner has advised that in circumstances where there is an adjustment to the profit of the company which results in the salary amount paid now being in error, she will generally agree to a request by the taxpayer for a retrospective adjustment to the shareholder salary. “Error” in this regard will rely on the taxpayer being able to prove historic trends such as the shareholder salary paid always being equal to the annual profits of the company, salaries only declared out of profits and not where losses incurred or that the salary has previously been based on a fixed percentage of annual profit.
An adjustment request is unlikely to be approved where an “error” cannot be shown to have occurred e.g. matter of regretted choice (taxpayer simply has changed their mind), or where all parties (company and all its shareholders) do not agree that an “error” has occurred.
The deadline for comment is 27 January 2017.
Tax Policy Work Programme Update
For those of you interested in following where your hard earned monies are being utilised in funding IR’s tax policy programme, the latest update has just been released. New topics on the agenda include reviewing the bank account requirements for offshore persons looking to obtain IRD numbers (obstacles to being able to comply with tax obligations have been noted), ensuring beneficiaries are not deemed settlors due to leaving distributions in current accounts (not policy intent) and considering the impact of recent case law on the “voting interest” test for corporate trustees (GST & income tax).
Older items of particular interest still under review include the tax treatment of income protection insurance policies (consistent approach), reform of the tax treatment of employee share schemes, various BEPS action plan issues and further work surrounding business transformation. A copy of the update can be found at https://taxpolicy.ird.govt.nz/work-programme.
Detailed Seismic Assessment Costs
IR has issued for re-consultation draft PUB00223, a QWBA on the income tax deductibility of costs incurred in obtaining a detailed seismic assessment (DSA) of a building. The item considers additional situations in which a DSA may be obtained, further to submissions received post the previous release of the draft.
IR now considers that in most cases, DSA costs will be on revenue account and consequently fully deductible. However, following its previously published “one project” principle, where DSA costs are incurred as part of either a capital project to seismically strengthen a building or a capital project to develop or improve a building, on this occasion the DSA costs take their nature from that project and are non-deductible capital expenditure.
Some typical examples of when costs will be considered to be of a revenue nature, include obtaining a DSA to satisfy existing or potential tenants of the buildings safety, insurance purposes usually to lower premiums, to evaluate a neighbours building with respect to its risk to yours in the event of an earthquake and to evaluate possible damage post an earthquake having occurred.
Submissions are due by 2nd December 2016.
Foster Care Payments
Legislative changes are in the wings to clarify that payments made to foster parents for the care of children and young people cannot be treated as income and consequently the amounts are not subject to income tax. Currently there are no legislative provisions in this regard (unlike a number of other childcare payments), which has resulted in inconsistency in the treatment of the receipts by different taxpayers. The proposed amendment is to be included in a Bill to be introduced into Parliament prior to the end of this year.
Trust Law Proposed Amendments Released
On 10th November 2016, Justice Minister Amy Adams released for consultation, draft legislation which will update NZ’s trust law. The release follows four years of work by the Law Commission in reviewing the Trustee Act 1956 and recommending changes to effectively modernise and provide greater clarity surrounding the administration of trusts – of which it is estimated 300,000 to 500,000 are presently in existence.
Submissions on the draft legislation are requested to be filed to the Ministry of Justice no later than 21 December, post which a final version of the legislation is expected to be introduced into Parliament in 2017.
The new legislation will, amongst other things:
- specify mandatory and default duties of trustees – default duties may be excluded/modified
- provide for a presumption that trustees must, as soon as practicable, provide basic trust information to all qualifying beneficiaries (reasonable likelihood of benefiting), unless trustees have
- applied qualifying factors which allow them to decide against providing information – so at least one beneficiary must be aware of the existence of the trust at all times
- provide for a more simplistic, flexible approach to the appointment and discharge of trustees where recourse to a court is not required
- abolish the rule against perpetuities and provide for a maximum duration of 125 years
The Stats Are Out…
IR has published the results of a recent survey of SME’s with respect to the time spent within their businesses during the 2016 income year attending to their tax compliance obligations. The median of 27 hours was down 25% on the last survey (2013). Understandably the most time consuming tax type was GST. IR has stated that digital enhancements to filing systems over the coming year should see further time reductions. The result was somewhat surprising to me considering feedback from our own clients, and I suspect you will also have your own views in this regard.
Minister’s Address to CAANZ Conference
CAANZ held their annual tax conference at the end of last week, which was kicked off as usual with a speech from the present Minister of Revenue (which in past years I have found to have had more of a political flavour than a taxation one). This year’s did appear more focussed on the latter however, the discussion essentially a recap of the past years activities (two tax Bills still to be enacted and continuing work on BEPS) and some of the changes proposed in the coming months (ensuring recent court decisions re voting interest tests do not alter Parliamentary intention for example) which are likely to be included in a tax Bill to be introduced in early 2017. The Minister also released a proposed timetable (to help you plan) which outlines general timings for the various issues IR is either presently working on or looking to commence work on during 2017. A copy of the timetable can be found at http://taxpolicy.ird.govt.nz/work-programme#timetable.
Greater Sharing with MSD
Proposals are afoot to increase the sharing of information between Inland Revenue and the Ministry for Social Development (MSD) and to merge a number of separate information sharing agreements into one document. The focus of the latest amendments are in the areas of housing assistance and student allowance entitlements. The consultation document suggests that greater sharing of information in these two areas, will enable MSD to provide better targeted housing assistance to those in need (reducing the present time consuming step of having to have discussions with a potential claimants employer before decisions can be made), and to process student allowance claims more efficiently by being able to more quickly verify student and parent income data.
Submissions with respect to the consultation document need to be received no later than 16 December.
Bloodstock Breeding – What If You Race First?
IR has released draft QWBA (PUB00290) which essentially deals with specific income tax and GST issues associated with a new bloodstock breeding partnership business that has purchased its first horse with a view to racing the horse for several years prior to commencing breeding. The specific income tax issue is whether a write-down for the horse in accordance with section EC 39 of the Income tax Act 2007, will be permitted in the first year. The draft concludes that as the provision requires that the taxpayer is in a breeding business and that a purchase of a horse in these circumstances will not be considered to be the commencement of such business, no write-down will be permitted. However a particular partner who is also a partner in another partnership that does have a pre-existing breeding business, will be permitted to claim their share of any deduction.
The GST aspect of the draft QWBA is quite fact specific (e.g. horse top pedigree costing more than $200k) and concludes a taxable activity is likely to exist, thereby entitling the partnership to a GST input claim when the horse is initially acquired.
While the QWBA is quite limited in scope, like most IR publications, the detailed analysis section of the document is a useful read, particularly in this case where more generalised topics such as commencement of a business, look-through nature of partnerships and whether a taxable activity exists are discussed.