Seizing the tax policy tiger
Seizing the tax policy tiger
Statement by Tax Partners Paul Dunne and John Cantin
Finance Minister Bill English today unveiled his second Budget - Building the Recovery - which reforms the tax system in the strong belief that a change is required to encourage work and saving, The Minister has taken some bold steps, not of all of which are politically palatable.
We welcome these changes as they will address the major issues identified by the Tax Working Group: the coherence and fairness of the system.
Despite the global financial crisis, the economic picture is much rosier. The Government's accounts are in better shape than was forecast twelve months ago. Government is expected to emerge out of deficits earlier than previously forecast (around 2015 rather than 2019), net Government debt falling faster and further (to less than 20% of GDP by 2023 versus 30% in pervious forecasts) and growth rebounding to around 3% over the next 3 years. Budget 2009 was aimed at keeping NZ afloat in turbulent economic seas. Budget 2010 is about re-charting the course to take advantage of the recovery.
In large measure, the Government has taken the work of the Tax Working Group and implemented it while also resisting some of the ad hoc measures advocated by the public. The good news on the fiscal front has allowed the Government to move further than was expected on the tax side, cutting the company tax rate and tax rates for savings through PIEs.
Taxing consumption to encourage savings
The shift in the tax base, from income tax to GST, forms the centrepiece of the Budget.
The Government has addressed the shortcoming that New Zealand is too reliant on raising revenue from internationally mobile tax bases (financial and human capital) - by moving more of the tax burden to consumption. From 1 October 2010, GST will rise to 15%. With new tax bases ruled out, raising the GST rate was the obvious and well-signalled choice. The GST is not easy to evade and covers a lifetime's consumption.
The motivation for changing the tax mix is to provide more appropriate economic incentives - to invest and save rather than consume.
No one worse off under a GST rise?
Any tax change needs to be sustainable politically. To compensate for the GST increase, there will be simultaneous increases in benefits and reductions to personal tax effective at the same time.
On average, benefits and superannuation entitlements have been increased by 2.02%, which the Government considers will fully offset the general cost of living increase under a 15% GST.
The current and proposed tax rate and threshold schedules are:
Rate (until 30 September 2010)
Rate (from 1 October 2010)
$0 to $14,000
$14,001 to $48,000
$48,001 to $70,000
Government estimates that someone earning $44,000 will be better off by $593 ($11 a week in the pocket) when the GST and income tax changes are combined. On an income of $100,000, the amounts are $2,167 and $42 extra per week.
Benefits of Tax rate alignment
The reduction in tax rates will also provide near alignment with the company and trust tax rates. The Tax Working Group recommended tax rate alignment to reduce opportunities to shelter income in companies and trusts. The reduction in the top personal rate to 33% will remove much of this tax rate advantage. This will improve the integrity of the tax system.
Property investment pays up
There were strong signals, pre-Budget, that the sector would be targeted. The Budget removes tax depreciation for buildings where the expected useful life is more than 50 years from the 2101-11 year. This will apply to most buildings.
The Tax Working Group's recommendation was that depreciation should be removed only if there is clear evidence that structures do not depreciate. The Government's conclusion is on average property does not depreciate in New Zealand and has changed the rules in line with this conclusion.
Business taxation (largely) stays the course
A minor surprise in Budget 2010 is an early reduction in the company tax rate. That rate will be reduced from 30% to 28% from the 2011-12 income year.
The new company rate matches Australia's but will see New Zealand companies receiving this reduction first. In Australia, large businesses will have to wait until their 2014-15 tax year while small business will receive it from 2012-13).
The removal of the 20% loading on tax depreciation rates (which accelerates the depreciation benefit) and the lowering of the thin capitalisation safe harbour ratio to 60% (from 75%) were expected. Both changes were identified as "quick-hits" by the Tax Working Group. The Government appears to have gratefully accepted both recommendations.
The reduction in the thin capitalisation safe harbour has been justified based on international norms. It is worth noting that other countries, including Australia, have significantly more generous accelerated deprecation schemes. A case of giving with one hand (the lower company rate) and taking with the other, for business.
Business will need to be content with greater spending on infrastructure and Research and Development. KPMG remains disappointed with the repeal of the R&D tax credit scheme after only a single year of operation. The justification at the time was the fiscal cost. We are pleased to see R&D tax credits resurrected as a grants scheme (albeit with a much reduced scope). The challenge for Government is to ensure that the costs and time of re-establishing the bureaucracy do not overly adversely impact the delivery of the grants to businesses.
Savings tax rates - PIEs
A consequence of reducing the company tax rate is a reduction in the maximum tax rate for Portfolio Investment Entities (or PIEs) to 28%. The other PIE rates (12.5% and 21%) are also impacted by changes in personal tax rates. These will also move to match the personal tax rate reductions from 1 October 2010. PIE and taxable income thresholds will not change.
Government allowed PIEs latitude to make the necessary systems changes when PIE tax rate reductions were last made in Budget 2008. It is clear that Government expects fund managers to have taken that opportunity to build flexibility into their systems, to update tax rates, as the timeframe to make these changes will be challenging for some.
A neutral package?
The aim of the package is to shift the tax mix but be overall neutral to Government. As well as the tax increases, the Budget estimates an approximately $1.3b benefit (over 4 years) from Inland Revenue audit activity (at a $5 return per $1 spent on Inland Revenue audits) and calculating the effect on Government revenue from increased economic activity generated by the package.
The Government is relatively safe in assuming that Inland Revenue will continue to deliver. Businesses can expect a continued robust approach to their tax positions to justify this faith.
This is the first time that we have seen a Budget explicitly accept that tax changes will drive economic behaviour. We look forward to Government costing future tax reforms on the same basis.
An aspirational Budget
The Minister of Finance emphasised the need to show both domestically and internationally that New Zealand is "ready for business". The Government has moved swiftly to take the opportunity that New Zealand's resilience has provided to move on both company and personal tax rates. Government is counting on this move and the brighter economic and fiscal balance forecasts to work to New Zealand's advantage on the path to recovery.
If Budget 2009 was crafted out of necessity, 2010 is an aspirational Budget. It takes a number of steps to reshape New Zealand's tax landscape. The question will be whether the changes are effective. Time will tell.