Family Business ~ Insight | A look at the Taxation of Foreign Superannuation and the Implications

The Taxation (Annual Rates, Foreign Superannuation, and Remedial Matters) Act was passed into law on 27 February 2014. The IRD has recently released a special report from the Policy & Strategy Division on the application of new rules to the taxation of foreign superannuation.

There are several points from this that have got wide application and readers should be aware of, being:

That where a New Zealand resident has received a lump sum payout from a foreign superannuation scheme and has not treated this as taxable or otherwise calculated tax on it in accordance with a foreign investment fund (FIF) Rules, they have an option of including 15% of the lump sum received in either their 2014 or 2015 income tax returns. This in effect a limited amnesty and is an opportunity that taxpayers who haven’t complied with their New Zealand tax obligations should take.

This also applies where amounts were transferred from foreign superannuation schemes back to New Zealand superannuation schemes, other than under the recent trans-Tasman portability of superannuation scheme provisions which allows the transfer of Australian pension fund interests by New Zealand tax residents into their New Zealand kiwi saver schemes.

From effect of the 2015 income tax year on (generally 1 April 2014 on), the FIF rules will cease to apply to interests held in foreign pension funds and only upon the payment of these pension funds or transfer of them to another scheme will a tax liability arise in New Zealand. Actual pensions will continue to be taxed also on a cash basis so in effect there is now a matching of pensions and lump sums so that both are taxed on a cash basis.

For taxpayers who have paid tax on such pension funds using the FIF rules, they can continue to do so. However, this is likely to be only beneficial when they are relatively close to retirement age and to accessing the lump sums. Obviously each person needs to take advice on their own individual situations.

One final interesting point out of the special report from the IRD is that they consider individual retirement accounts or IRA’s as they are known in the USA to be superannuation vehicles because they are mainly for the purposes of retirement saving. This is an unusual position to take as the generally held view in New Zealand has been that these accounts are more likely income deferment accounts than retirement saving accounts, as it has been possible to access the income prior to retirement without necessarily incurring significant penalties. However, at least now we have a position from the IRD and it is generally more beneficial than many taxpayers would have previously believed the case.

Taxation (Annual Rates, Employee Allowances and Remedial Matters) Bill. The financing select committee has reported back on this bill. From our previous newsletters you will understand that it relates to a variety of matters which will effect a lot of taxpayers in New Zealand.

The financing select committee have noted the following:
1 That the proposal to insert a definition of the date of acquisition of land for the purposes of part CB of the Income Tax Act 2007 should go head, but needs some further clarification. In effect, the date of acquisition will be the date that a person first acquires an equitable interest in land. While this is not always clear, it is something that can be worked out from the contracts.
2 The employee accommodation expenditure provisions are going to get a further makeover. The Select Committee has recommended that four exceptions are created to allow for situations involving shift work or remote work places. Where it is considered that it would be inappropriate to tax accommodation provided in connection with employment. These exceptions proposed would cover mobile work places such as ships, trucks or oil rigs, a station in Antarctic, lodging provided for shift workers such as fire fighters, ambulance staff and caregivers; and accommodation provided at remote locations where an employee is expected to fly in and our such as mines in Australia.
3 They also propose that the Commissioner is given the ability to extend this list of exceptions should others that are unforeseen currently become an issue by way of order in council.
4 The balance of the provisions relating to accommodation and meal payments are largely subject to minor tweaking. Meal payments will be clarified where they are work related costs with the full amount of meal payments and light refreshments being exempt if provided for work related events with payments linked to work related travel exempt for up to 3 months. It is also proposed that light refreshments including snack foods, tea, coffee and the like are exempt without time limit.

FATCA information sharing.
The Bill also proposes law changes to facilitate the sharing of account information with the United States under what is known as the FATCA (the Foreign Account Tax Compliance Act) which is due to come into effect on 1 July 2014. While this has been discussed before in our newsletter, it is interesting to note that there has been some significant compliance cost associated with this for financial institutions. Moreover, the definition of who is a financial institution is catching many other parties including potentially accounting and law firms who hold moneys in their trust accounts for people based in the United States or who are otherwise United States citizens or green card holders. This could easily capture people living in New Zealand who are still caught in the US tax net so care needs to be taken by anybody dealing with US citizens and their money.

If you would like to discuss the implications of the new law for your situation please email or call Nigel Smith.

Family Business ~ Insight | The Barometer is Climbing

Late in 2013 there was a definite pick up in the economic activity in the New Zealand economy, particularly in Auckland. Many professionals and business owners had anecdotally been saying that 2013 was a terrible year. For us it had been binary: either we were flat out or we had nothing to do at all. There was simply nothing in between.

So far 2014 has seen a return to what I would refer to as normality with a more constant work flow but greater confidence overall out there. We are seeing a greater interest from clients in doing things be they commercial property acquisition or development, residential property development or simply business expansion.

We certainly have seen the benefit of the special housing accord with several projects centred on clients getting approval to designate existing pieces of land as SHAs. This will fast track development of the land and naturally the housing stock in Auckland.

The counter to this is the spectre of rising interest rates. While we have seen a long period of historically low interest rates, normalising does need to occur at some stage and that will definitely slow economic confidence and activity. For every $100,000 someone has borrowed, a 1% interest rate increase equals about $80 a month in extra outgoings. With the high levels of debt particularly for personal house acquisition and rental properties, this will have a significant flow on effect and could well slow down the housing price boom in Auckland.

The election also looms large with an early election date in September. The question will be what happens with the minority parties and the uncertainty around this is likely to slow economic confidence down from June on in our opinion.

Finally, one of the biggest issues that we have seen in the last 12 months is what we are calling the Australian disease. With a slowdown in economic activity in Australia, many Australian businesses have been forced to review their overhead structures and downsize. Unfortunately for New Zealand, many New Zealand businesses are either branches or subsidiaries of Australia and instead of getting rid of their mates down the hall, the Australian bosses and accountants are getting rid of people in New Zealand. Sadly, these New Zealand businesses are actually very profitable but the reality is that the people making the decisions don’t want to get rid of people who are their friends, and instead choose to get rid of people further away that they don’t need to deal with. I have seen two examples of this in the last few months myself with profitable businesses being forced to downsize in New Zealand simply because the Australian operations are not performing. This is a real economic threat to New Zealand.

So where we end up for 2014 and beyond no one knows but at least everyone is a bit happier about the outlook. The surveys and confidence indexes are showing positive signs and at least that means improvement in the economy. Here’s hoping that it’s a quick road to recovery and that 2014 is indeed better for everyone.

Nigel Smith

Family Business ~ Insight | Penny & Hooper, Alesco and the Aftermath

Tax has always been an art, not a science. It has always been about interpretation and not necessarily objective fact.

Post the cases of Penny & Hooper, Alesco and the other anti-avoidance cases, life has become very different in the tax world. Formerly we successfully argued that unless the Income Tax Act said we couldn’t do something, we were able to do it. Now we are faced with a situation where the reverse is true that unless a Tax Act clearly says that we can do something, we cannot do it.

What does parliament contemplate when it passed a piece of law? Most of the time they don’t even know themselves. Given that the IRD is also a party to the introduction of new law along with treasury, it might be better to rename “parliamentary contemplation” as “IRD desire”.

In an audit situation we are often faced with IRD auditors, often very young and inexperienced, telling us what parliament contemplated. It is very difficult to determine what parliament contemplated because the law itself often it not clear. Even a seemingly simple piece of law like the mixed asset use rules do contain complexities and are very hard to understand when you try to apply them to actual factual situations.

We all know now that you are not entitled to use companies to trade through, pay yourself a lower salary and then take the profits out by way of dividend to avoid the 6% increase in the marginal tax rate that the labour government bought in. However, you can sell your existing house to a company or LTC so that you can then get an interest deduction when you buy your new home. Clearly the only purpose for doing this transaction is to obtain an interest deduction yet in the eyes of the IRD that is not tax avoidance.

As we have seen with the Alesco case, the problem with all of this is the cost of getting it wrong. Alesco was faced with a situation of having to loan funds from a parent in Australia to a subsidiary in New Zealand and chose a structured financing option that gave a favourable tax outcome. When the IRD applied the anti-avoidance rules, it annihilated the whole transaction. The tax payer was not entitled to return to the position that it would have been in otherwise, it simply lost all of the deduction. An example of this in the real world would be if you got caught doing 115kmh in a 100kmh zone, you would get a ticket for doing 115kmh over the speed limit. While it is not a great example, it does show the absurdity of the situation.

Add to this the cost of penalties, use of money interest and the cost of fighting the IRD, it is certainly a very difficult world in which to give advice. Often it is also not about taxpayers trying to do something that is aggressive, but simply to try to find out what the position is.

In recent years I have been one of the highest users of the IRD’s binding rulings unit. The reason for this is it provides taxpayers with certainty in a given situation. The downside is that there is time and cost involved in obtaining a binding ruling but in many transactions, it is a worthwhile outcome and wait. While I can provide opinions to clients, at the end of the day there may not be certainty and by going to the IRD to obtain a binding ruling, it is certainly a sensible outcome.
The IRD recently released its interpretation statement on tax avoidance. At the end of the day, it is a very useful document and all credit to them for putting this out. What it lacks however is a significant number of examples which can be used to test situations against. It is somewhat too conceptual and academic in its composition to actually be useful at the coal face.

The next few years are certainly going to be interesting in terms of tax payers and their relative and perceived level of risk.

Family Business ~ Insight | IRD Hospitality Audits

Over the last year we have been working on a number of IRD audits of bars, cafes, pubs and restaurants. While these are not particularly great money spinners for the IRD relative to the effort they need to put in, the auditing of this area has to be welcomed as it improves the overall compliance by taxpayers in the economy with their tax obligations. The cash economy has been alive and well in the hospitality world and as such, the watchful eye of the IRD being bought to bear on them has certainly been successful for the IRD. From my experience, all if not most of the audits that they have undertaken have resulted in fairly sizeable adjustments.

However, that is not to say that necessarily the IRD is always correct. They are certainly entitled to use industry averages to sample which taxpayers to look at, but they then cannot try to assess them based on those same industry percentages. An average is an average, at the end of the day some people will be above it and some will be below it. For taxpayers who make a lower than average GP, there are also those who make a higher than average GP. If the IRD wants to try to increase the amount that a lower than average GP hospitality business pays tax on, then they must also reduce it for those that are above the average. The New Zealand tax system does not work by taxing businesses on a standard expected margin or amount of profit dependent on the type of business they are in. The IRD simply cannot do this.

Secondly, the IRD has in my opinion often adopted bully tactics in relation to the way they have handled these audits. They haven’t quite rammed the door down and administered truth serum, but they certainly have used a large arsenal of their weaponry and in many cases simply haven’t listened to common sense. The IRD has continued to try to apply a view that all taxpayers are villains, and that anything unexplained is therefore taxable. Often there are very valid reasons for things which the IRD simply does not accept.

Interestingly however, if you back out the recent hospitality audits, and the few banking and financial institution cases that are still being settled following Alesco, the IRD has been relatively quiet in its audit activity also shown by the fact that it has been relatively down in its collection of penalties from audits.

Family Business ~ Insight | Are you applying the Mixed Asset Rules correctly?

We have spent a lot of time working with the new mixed use asset rules, as we have a number of clients with expensive baches, launches and aeroplanes that are used on a mixed use basis. While the intent of the rules is relatively straightforward, to be honest we have at times found it difficult to apply the actual law to factual situations.

The thing that will catch people is the GST adjustment. With the new mixed use asset rules, people need to recalculate their business use percentage based on the new rules. As a consequence of this, an output tax adjustment is required based on either past use or estimated forward use. We have worked on a US$10m plane so as you can tell, the cash flow consequence of this can be significant.

This is particularly the case when you consider that the GST rules changed in 2011 so that inputs were no longer based on the primary and principal test, but rather the expected use of an asset. As an example whether an asset is used 10% for business or 80% for business that becomes the relative percentage input both of the capital item and in terms of the ongoing operating and holding costs for GST purposes.

Many taxpayers and GST registered persons have not thought about the consequences of the GST adjustment, and it will catch out many with holiday homes, boats and planes who have previously had them in the GST net. The increase in rate to 15% also won’t help.

If you would like to discuss the rules and how you are currently applying them please email or call Nigel Smith.