New Zealand entrepreneurs face ‘distortionary’ tax rules

This article was current at the time of publication.

New rules proposed by New Zealand’s Inland Revenue Department (IRD) will impede business growth and entrepreneurship in the country, CPA Australia believes.

The rules are aimed at individuals channelling income through corporate structures to “arbitrage” the difference between the company tax rate and higher personal income tax rates.

In its submission to the discussion document, Dividend Integrity and Personal Services Income Attribution, CPA Australia strongly opposes the introduction of the new measures in their current form, arguing that increased compliance costs across all New Zealand businesses will outweigh any expected benefits.

These added costs will also likely result in improper taxation of capital gains.

The proposed measures affect companies’ retained earnings that will be deemed taxable on the sale of a business by shareholders and how business owners’ remuneration is taxed when they provide personal services to an associated entity.

The deemed dividend proposal “seeks to more clearly separate capital gains from retained earnings to ensure that income tax is paid on the latter while maintaining the tax-free status of the former,” the submission argues.

It notes that “the proposed mechanics of the deemed dividend rules are exceptionally complicated”.

Feedback from CPA Australia members suggests the ability to supply the required documentation – including records of retained earnings along with details of the Imputation Credit Account, Available Subscribed Capital, and/or available Capital Distribution Amounts – will be highly variable, particularly for smaller businesses.

These would potentially have to be produced not only for the past seven years, but for every year the business has operated, as the period for which the Commissioner could demand them is unlimited.

SMEs burdened by complexity

According to the submission: “Whether by design or default, the current tax proposal will impact on a very large group of economically important taxpayers, i.e., small businesses, with limited evidence that they all need to be subject to such complicated tax measures.

“We note that in prior years, tax administration policy was committed to simplification for small and medium enterprises.

“This proposal stands in contrast to this philosophy by introducing concepts and approaches that introduce complexity and cost.”

CPA Australia New Zealand Divisional Council President Angus Ogilvie FCPA points out that the bar for offering services as a tax agent is very low and agents who are not qualified accountants would need considerable support from the IRD to negotiate the changes.

Ogilvie expects all businesses to experience increased compliance costs, “and, of greater concern, there is the real likelihood of improper taxation of capital gains due to weaknesses in many businesses’ record keeping processes”.

Although there is limited data in the discussion paper to accurately assess its true impacts, CPA Australia is adamant the proposed changes will potentially affect hundreds of thousands of businesses, with costs far outweighing any benefits.

PSI changes impede growth

The submission argues that proposed changes to personal services income (PSI) attribution rules suggest most personal services businesses (PSBs) will be required to attribute income to the working person, to be taxed at their marginal rate, impacting the ability to retain earnings for goals such as future growth and investment, to fund business acquisitions, to hire staff, or to take risks.

For start-ups and new businesses, this could significantly impede access to capital, introduce cash flow difficulties and reduce growth prospects.

“In our view, the government should be supporting small business growth and encouraging entrepreneurship, rather than demanding businesses retain no earnings so that income can be taxed at higher rates,” Ogilvie says.

By targeting only PSBs, he says the rules would also introduce unequal treatment of companies solely by the economic nature of the business; services people would be affected but not, for example, plumbers or electricians.

Anti-avoidance tools in place

He says the IRD already has tools to address tax arbitrage by business owners through general anti-avoidance rules (GAAR), audit and risk review.

“In effect, it’s a white-collar tax.”

The proposals also seek to address the issue of business owners channelling employment income through corporate entities to avoid higher personal tax rates. The “80 per cent one natural person supplier” test would be reduced to 50 per cent.

CPA Australia opposes the change, arguing the reduction “again disregards the economic value generated by other natural persons participating in the business and significantly constrains the ability of the business to increase its value”.

“Given the breadth of affected taxpayers, we suggest that Inland Revenue first undertake and publish a regulatory impact analysis that also considers existing and alternative options such as the enhanced enforcement of GAAR and more active use of Revenue Alerts. 

“This should include estimates of the revenue at risk, the revenue impact of the proposed changes, the affected population, and the potential revenue gain from over-taxation due to the deeming rules taxing all but the most evidenced and contemporaneously reported capital gain amounts.”

Other changes sought include a limitation of the Commissioner’s review period and simplified approaches to reduce the compliance cost for smaller businesses.

Some assurance would be required from the Commissioner that the IRD’s compliance approach would help advisers and their clients to adapt.

Ogilvie’s view is that the IRD – following the completion last year of its NZ$1.7 billion IT upgrade – is incentivised to “systemise” tax administration.

“They need to populate that system with data, but it’s practitioners and their clients who’ll bear the cost of providing it,” he says.

Ogilvie argues the New Zealand Government should bear in mind that the capacity of businesses to absorb greater compliance costs has been impacted by two years of coronavirus-forced restrictions.

“It is important to understand that many businesses are not currently in a position to transform their accounting systems or establish and maintain detailed records of far-off events,” he says.