Cullen Address To Annual Intl. Fiscal Assoc. Conf.
Hon Michael Cullen
29 April 2005
9am Friday 29 April 2005
Address to 28th Annual International Fiscal Association Conference
Crowne Plaza Hotel, Kilmore and Durham Sts, Christchurch
Last year the government's main focus in the area of tax reform was on providing a fairer deal for working families. The fruits of those labours were the tax changes in the Working for Families package in last year's budget. They are already delivering benefits. From 1 April this year, 260,000 families will be entitled to extra money for living costs, housing and childcare.
The focus of tax changes in this year's budget will be on facilitating savings, increasing New Zealand's access to worldwide labour, skills and capital, and ensuring their efficient use so as to increase productivity and grow the economy.
This is an ambitious tax programme, and it will be implemented in a way that maintains the government's strong fiscal position. That fiscal position is what establishes the parameters for tax changes, and it needs to be considered over the long term, where there is not as much headroom as many are claiming. For this reason I want to deal first with the fiscal position before announcing some specific tax policy proposals.
The major rationale for the government's policy of running strong fiscal surpluses is the need to place the nation's finances in a strong position to prepare for the higher costs we can expect in the future. Many of these costs relate to the growing proportion of the population who will be elderly. New Zealand, like other developed countries, faces substantially increased health and pension costs in the future. The increases in total age-related spending are likely to be significant and long lasting, and so fiscal policy that takes no account of this will lead to an increase in the debt-to-GDP ratio starting in around 10 years time. Clearly, rising debt levels would lead to higher debt servicing costs that, in turn, would require funding through lower spending and/or higher taxes. This in turn would create a fiscal position that is vulnerable to economic shocks - a situation previously encountered in New Zealand's history.
Consequently, the government's fiscal strategy is to strengthen public finances over the longer term, to prepare for the future costs associated with an ageing population. To achieve this we set a number of long-term fiscal objectives. They are:
- to run operating surpluses on average across the economic cycle sufficient to meet New Zealand Superannuation Fund contributions;
- to meet capital spending pressures and priorities;
- to ensure that revenue and expenses are consistent with the operating balance objective; and
- to manage total debt at prudent levels
Some commentators have focused on the size of the operating surplus. They have concluded that there is a large store of cash that, for some inexplicable reason, I refuse to use to increase expenditure or cut taxes further. This view fails to appreciate that the operating surplus is not available solely for tax cuts or expenditure, but is also used to fund capital expenditure, to build up the New Zealand Superannuation Fund, and to maintain debt at prudent levels.
Last year, to strengthen the role of the debt objective as a "fiscal anchor", we lowered the debt-to-GDP objective so that gross sovereign-issued debt as a percentage of GDP would slowly reduce over the longer term, passing through 20 per cent of GDP before 2015. In short, we recognise that a sound fiscal policy is one that takes a longer view, reacting to pressures long before they impact. Only by adopting prudent fiscal management can we advance our key priority areas.
In preparing for this year's budget, I have been careful to ensure that decisions we take now will be consistent with our long-term strategy. Government revenue and expenditure are very large numbers, and shifts of a relatively small magnitude can quickly turn a favourable outlook into an unfavourable one. For example, the forecasts presented in the December Update showed gross debt falling to 19.6 per cent of GDP in 2008/09. But if growth in education and health spending were to continue at recent rates, gross debt would start to rise as a share of GDP beyond 2009. This shows how important it is not to lose sight of the longer-term fiscal position when making short-term decisions.
I have also been very aware that the New Zealand economy, which has outperformed the OECD average over the past five years, is facing capacity constraints. As such, I am wary of putting further pressure on already overstretched sectors of the economy in the coming year.
This forms the backdrop to both the tax policy decisions I am announcing today and the tax and spending policies I shall announce in the budget. As responsible economic managers, we look not only to provide a stable fiscal framework that will support the economy, but we also take active steps to enhance our economic growth prospects. In this year's budget we will continue with the Growth and Innovation Framework, as well as announcing further measures to support labour productivity growth. We will also progress new initiatives to encourage a savings culture, and to assist businesses with compliance.
Budget announcements that will be of particular interest to this audience concern work-based savings, the related issue of the taxation of investment intermediaries, and tax depreciation.
We have an ambitious tax policy work programme. Fiscally, the most significant of the areas I am discussing today relate to tax simplification and fringe benefit tax proposals.
Making tax easier for small businesses
I turn first to tax simplification for small businesses.
Two years ago the government put out for consultation a series of proposals designed to make tax compliance easier for small businesses, a sector of the economy that can be disproportionately affected by such costs.
One of those proposals was to make available a new 6.7 per cent discount - the equivalent of a 10 per cent pre-tax discount - to many self-employed people and members of partnerships in their first year of business if they make early payments of tax during that first year. The idea is for the government to help reduce some of the financial strain that small businesses face in their first three years of business. The discount has been enacted and came into effect this month.
The fiscal cost of the discount is estimated to be negligible over the forecast period, 2005/06 to 2008/09.
Three other proposals from the same source have now worked their way through the policy process and are set to be included in a taxation bill planned for introduction in late May. They relate to the alignment of payment dates for provisional tax and GST, basing provisional tax payments on GST turnover, and a subsidy to payroll agents for meeting PAYE-related compliance costs imposed on small employers.
Inland Revenue research has shown that the two most significant tax compliance costs faced by small businesses are: the time needed to fill out forms; and the fact that provisional tax payments are not aligned with cash flow. Businesses and individuals pay provisional tax in three large instalments during the year, and most pay GST every two or six months. However, many of the small businesses that were consulted said they would prefer to pay provisional tax more frequently, to help with their budgeting.
As a result of the consultation process, the alignment proposal in the forthcoming taxation bill will be a modified version of that floated in the discussion document. The current three provisional tax payments will be aligned to GST due dates, and small businesses will be able to make voluntary payments during the year.
This should suit most businesses. Those who want to pay more frequently, as they earn their income, can make six payments a year. On the other hand, those who do not want to pay provisional tax more frequently will be able to continue with the three payment date system.
A complementary change in the tax bill will give GST-registered businesses the option of basing their provisional tax payments on a percentage of their GST turnover. This will suit businesses that have seasonal income, since their tax payments will be more closely aligned with income flow.
These two measures are estimated to have a combined cost over the forecast period of around $100 million. The impact on the operating balance looks much larger because the deferral of payment dates by about two months will shift $760 million of tax revenue out of 2007/08.
I confidently predict that this particular aspect of the budget will be misunderstood and misinterpreted by those who have a reason to do so, but I am not going to let sensible tax reforms be stymied by such efforts. It is the longer term fiscal position of the government, rather than yearly changes, that should drive decision-making.
The third major change in the bill arising from the discussion document on making tax easier for small business concerns the introduction of a subsidy to encourage small businesses to take advantage of the help that payroll agents can give them in meeting their PAYE obligations.
When businesses take on their first employees they take on a whole new set of payroll obligations, which - in addition to PAYE - include deducting child support and student loan payments from staff wages. Using a payroll agent can help with the extra work, but that is not something most small businesses do.
The subsidy will be paid to payroll agents in respect of a maximum of five employees of a small business. The bill will introduce a mechanism that allows a subsidy to be set by regulation for an amount that will be decided by negotiation with payroll agents.
Although this measure does not have an impact on the government's tax forecasts, it will have an impact on expenditure, estimated at $45 million over the forecast period.
Changes resulting from the government's review of fringe benefit tax will also be included in the forthcoming bill. The focus of the review, which began in 2002, has been on simplifying and improving FBT so as to reduce compliance costs, while dealing with base maintenance and tax policy concerns. Over $400 million in revenue was raised from FBT in the year ending March 2004, two-thirds of which was from motor vehicles provided by employers.
The tax treatment of motor vehicles was the main concern of the majority of those who made submissions, both when we invited submissions on the issues people thought the review should cover, and later when we released a discussion document setting out proposals.
The package of changes that I shall outline shortly has involved extensive consultation with business and stakeholder groups.
The government has decided not to proceed with all the proposals canvassed earlier. For example, the proposal to extend the FBT rules to include car parks provided by employers in the CBDs of major cities will not proceed. While such a change could be justified on policy grounds, submissions expressed a great deal of concern about its practical application.
Nor will there be any change to the FBT boundary for vehicles used for both business and private purposes. Submissions considered it to be a key area where change was needed, and not surprisingly, the overwhelming view of submissions favoured the most fiscally expensive option; that is, to retain the exemption for work-related vehicles but also halve the FBT rate on other vehicles used primarily for work purposes. The fiscal cost of this was too high for this year's budget, amounting to over $60 million a year, or $190 million over the forecast period.
The issues here are complex and require distinctions to be made between private and business use as well as between the cost to a firm of making a fringe benefit available to an employee and the value of the benefit the employee receives. I have therefore instructed officials to undertake further policy work in this area, in order to achieve the best balance between the appropriate recognition of the business use of a vehicle and the need to tax the private benefit element.
The bill in May will, however, introduce several changes to the FBT treatment of motor vehicles, including the following:
- Owners will have the extra option of calculating the motor vehicle fringe benefit based on a vehicle's tax book value as an alternative to using the vehicle's cost price.
- In recognition of lower real motoring costs since the 1980s, the fringe benefit valuation rate applying to the cost price of a motor vehicle will be reduced from 24 per cent to 20 per cent of the cost. The equivalent tax book value rate will be 36 per cent.
- The treatment of leased vehicles will be aligned with that of owned vehicles, meaning that the fringe benefit from a leased vehicle will be based on its cost or tax book value - rather than its market value, as at present.
The bill will also include a number of FBT changes that are not related to motor vehicles. For example, the minimum value thresholds applying to unclassified fringe benefits will be raised, to reduce compliance costs. The employee minimum value threshold will go up from $75 to $200 per quarter, and the employer threshold will rise from $450 a quarter to $15,000 a year. This will reduce compliance costs for businesses by reducing the need to measure and account for FBT for minor benefits. For some it will mean that FBT returns will no longer need to be filed.
Similarly, the private use of employer-owned or leased business tools such as cell phones and laptop computers will be exempted from FBT when they are provided to employees primarily for business purposes, as long as they cost no more than $5000. The change recognises that it is difficult and therefore expensive for employers to monitor and value the private use of these items. For example, when a business provides laptops to employees it will no longer have to worry about FBT liabilities should the computer occasionally be used to play games.
These are some of the main features of the FBT changes to be included in the bill. Subject to the progress of the legislation, the changes will apply from 1 April next year.
The overall fiscal cost of the fringe benefit tax measures is estimated to be $28 million a year, or $84 million over the forecast period.
FIF rules & Australian superannuation funds
I am also proposing changes that will help to resolve problems associated with the New Zealand tax treatment of accrued entitlements in foreign superannuation schemes. The issue was raised at last year's Australia-New Zealand Leadership Forum in the context of Australia's Superannuation Guarantee Scheme.
In Australia, employers generally make compulsory contributions into Australian superannuation funds on behalf of employees, who do not generally have access to their superannuation entitlements until they reach retirement age. Those who come to New Zealand for long-term or permanent employment - whether Australians or returning New Zealanders - may be required to pay tax on those or subsequent entitlements under our foreign investment fund rules.
There are exemptions under the rules, but determining what qualifies is not always easy and can create high compliance costs for the people involved. Moreover, business feedback has been that the potential tax consequences are a disincentive to people taking up permanent or long-term employment here - and this at a time when the government is looking at a variety of measures to attract highly skilled people to New Zealand.
Subject to the outcome of further work by officials, we propose to exempt specified Australian employment-related superannuation schemes from the foreign investment fund rules. We will need to work with Australia on the proper scope of any exemption. For example, should it encompass all Australian superannuation schemes generally, rather than be limited to employment-related superannuation schemes? That is one of the matters to be considered.
Maintaining the open labour market between Australia and New Zealand is a major benefit of CER. The superannuation issue is an impediment to that aim so is a top priority for the Australia-New Zealand Leadership Forum, which is being held in Melbourne today.
I hope to be in a position to make specific decisions on the matter so that any amending legislation can be included in the first taxation bill to be introduced next year.
The foreign investment fund rules will also be amended to make more generous the current exemption for interests in employment-related foreign superannuation schemes. At present, the exemption applies only to new migrants and only to entitlements acquired while the person concerned was not a resident of New Zealand. The May bill will extend the exemption to returning New Zealanders as well.
It will also cover all entitlements that were acquired when the individual was resident overseas as well as those acquired up to the end of the fifth year of each new period of New Zealand residence. The exemption will take effect for persons who become resident in New Zealand on or after 1 April 2006.
The government's proposed foreign trust policy is another area where we have worked extensively with affected taxpayers to produce good, workable tax policy.
Under current law, foreign trusts that have New Zealand-resident trustees but receive no New Zealand income are not required to provide information to Inland Revenue on a regular basis, or to keep New Zealand tax records. There is no need for that, since they are not taxed here, and rightly so, because they are outside our tax base. However, a problem arises for the tax authorities when other countries with whom we have double tax agreements request tax information on foreign trusts that have a presence here, as they are entitled to do under those treaties.
This has been of particular concern to the Australian government. Our bilateral relationship with Australia is critical to us but, at the same time, we do not want to impose rules that unnecessarily hinder legitimate New Zealand business. We have therefore worked with those who will be most affected by any policy changes in this area.
The government has sought to develop policy that works for all concerned, one that enables New Zealand to co-operate with other tax jurisdictions while not disrupting the legitimate financial transactions of foreign trusts. There have been two rounds of very productive consultation involving people such as trustees who act for foreign trusts and overseas practitioners who advise their clients on the use of New Zealand's foreign trust rules.
As a result, New Zealand-resident trustees of foreign trusts will have to provide only limited information to Inland Revenue when the changes take effect and keep financial records in New Zealand for each trust. At least one New Zealand resident trustee of each trust will be required to be a member of an organisation that has been approved by Inland Revenue, such as an accounting or legal organisation.
Trustees will not be required to provide detailed financial information to Inland Revenue unless a trust has an Australian resident settler, or one of our partners to a double tax agreement requests information.
The changes will be included in the forthcoming taxation bill and, once enacted, are expected to apply from April next year.
Unbundling payouts from co-operatives
We often work closely with business on tax consequences that arise from broader commercial initiatives. For example, the government was recently asked to respond to the tax consequences that arose out of Fonterra's proposal to "unbundle" payouts to member shareholders.
Unbundling would provide greater transparency for member shareholders. Separating out the components of the payout would improve price signalling and give member shareholders better information about the company's performance.
The tax consequence, however, is that if the payout is unbundled, there is a risk that the part of the value-added portion of the payout that is related to non-member transactions, would be treated as a dividend. This might mean that the company would not be able to claim a deduction for the amount and would then have to pay the tax itself.
The government was able to move quickly on the matter, with policy officials meeting with all affected parties to work out a legislative solution to the tax problem, and consulting widely with other interested parties to ensure that its application is consistent for all co-operatives.
The result is that the forthcoming bill will contain an amendment confirming the full deductibility of payouts, including the entire value-added portion, by co-operative companies to members. In this way the tax rules will not be an impediment to a move that has a broader commercial rationale.
Taxation of foreign hybrids
In a similar manner, the government has been working with business to resolve a problem relating to the taxation of New Zealand investments into fiscally transparent foreign entities, which are generally known as "foreign hybrids".
These entities, which have become more common over the past ten or fifteen years, have the characteristics of both companies and partnerships. Like companies, they have limited liability and sometimes a separate legal personality, but tax is paid by the partners or shareholders rather than the entity itself.
The problem arises because a foreign hybrid is taxed as a company in New Zealand but may be taxed as a partnership elsewhere. In that case, foreign tax credits for foreign tax paid by the New Zealand investors are not available to New Zealand owners of the entity. Another problem is that a foreign hybrid cannot qualify for the so-called "grey list" exemption.
Policy officials have worked with groups such as ICANZ, the Law Society and the Corporate Taxpayer group to find a practical legislative solution. The result is an amendment in the May bill that will ensure that tax credits will be available to New Zealand investors for foreign tax paid in relation to foreign hybrids and that foreign hybrids will be eligible for the grey list exemption.
The change will therefore align the tax treatment of investments into foreign hybrid vehicles with the treatment of investments into other foreign companies.
Some tax consequences will also arise from government plans to modernize the special partnership legislation in the Partnership Act 1908, replacing it with special rules on limited partnerships, which will have a separate legal personality. The aim is to remove tax and regulatory barriers that impede the flow of foreign venture capital into New Zealand and to create rules that will provide clarity to investors and reflect international best practice.
Limited partnerships developed in the United States and have now become the preferred method of investment, especially for venture capital. Countries such as Australia and Singapore have recently introduced limited partnership rules so that they can attract foreign investment.
New Zealand needs to keep up with these developments if we want this valuable flow of funds, and we shall do so.
The Minister of Commerce will be announcing the details of the reform later today.
This has implications for tax, since entities with separate legal status are taxed as companies under current tax law, although investors will doubtless want to retain "flow-through" treatment for tax purposes. Therefore it would seem that substantial tax changes will be needed, but further policy work will determine their nature and scope. I hope to be able to release a discussion document on proposals for dealing with the tax-related issues later this year.
Geothermal exploration & development
Policy work is also under way on the tax treatment of geothermal exploration and development. A number of concerns have been raised about the lack of tax certainty in relation to geothermal exploration and development activities. This is a situation that some within the industry regard as disadvantageous. As a matter of priority, tax policy officials will be working with the industry to develop more workable tax rules, and if all goes well I hope to be able to include changes in the first taxation bill to be introduced next year.
Finally, I want to mention the issue of extending legal-type privilege to non-legal tax advisers. As you know, the matter is in legislation currently before the Finance and Expenditure Committee. The legislation requires more than normal development in select committee because of the tight timetable to get this into the last taxation bill. I am following the issue closely, and my policy officials are working with those involved to ensure that we achieve a workable regime that meets the objectives I have previously discussed with many of you. I am totally confident that we shall achieve a good outcome.
To conclude, the measures I have announced today are the result of government working with business to improve our tax system. I appreciate the effort that many of you have put into consultation to produce this result, and I thank you for that.
The announced measures do not come without a fiscal price tag for the government. The total fiscal cost of the tax simplification and fringe benefit tax measures is estimated to be $230 million over the forecast period. There are real tax reductions and real benefits to business. I will be announcing further tax measures in the budget. The overall "business package" in the budget will be partly funded by revenue from a carbon tax, details of which will be announced shortly.
I wish you a very successful conference, and trust I have provided you with some additional topics of discussion.
Looking ahead, I am quite proud that in the election later this year we will go to the country and offer more of the same.