Two tax bills were introduced into Parliament on 17 May 2007 after the Minister of Finance delivered the Budget.
The first Bill, the Taxation (KiwiSaver and Company Tax Rate Amendments) Bill, was passed by Parliament on Friday 18 May (the House sat under urgency) and received the Royal assent on 21 May 2007.
The second Bill, the Taxation (Annual Rates, Business Taxation, KiwiSaver, and Remedial Matters) Bill has had its first reading and been referred to the Finance and Expenditure Committee (FEC), which will call for submissions on it shortly. We anticipate the FEC setting an early July deadline for submissions.
The first Bill:
reduces the company tax rate from 33% to 30% from the beginning of companies’ 2008-2009 income years (1 April 2008 for companies with standard balance dates);
reduces the tax rate for certain savings vehicles (such as unit trusts, widely-held superannuation funds, some group investment funds (GIFs) and life insurance policyholder funds) to 30% and caps the top rate for portfolio investment entities (PIEs) at 30% instead of 33%;
introduces a tax credit for employees’ contributions to KiwiSaver (or complying superannuation funds) of up to $20 per week. The credit will match an employee’s contributions dollar for dollar up to the cap; and
makes a number of remedial amendments to the PIE tax rules.
The second Bill (called ‘the May Bill’) introduces:
compulsory employer contributions to KiwiSaver from 1 April 2008. The compulsory contributions will be phased in over 4 years, starting at 1% and reaching 4% of gross salary or wages from 1 April 2011;
a tax credit for employers that will reimburse them partially for their contributions to KiwiSaver. The tax credit is capped at $20 per week per employee;
refundable tax credits for research and development (R&D) expenditure;
greater tax incentives for charitable giving including the removal of the current rebate threshold for individuals’ donations and the 5% limit for donations made by companies;
amendments that liberalise a range of tax penalties;
amendments to the tax legislation to reflect changes following the adoption of International Financial Reporting Standards (IFRS) particularly in relation to the financial arrangement rules, R&D expenditure and the trading stock rules;
a number of company tax rate transitional and consequential amendments; and
other minor and remedial amendments.
The May Bill should be passed in the final quarter of 2007.
For more details see the stories below on KiwiSaver, R&D tax credits, the corporate tax rate change, charitable giving and tax penalties.
The ‘new’ KiwiSaver
The Government’s latest round of modifications to KiwiSaver announced as part of Budget 2007 make it a significantly more attractive savings vehicle than was originally rolled out in 2005.
In the third article in our series counting down to KiwiSaver’s introduction on 1 July 2007, we answer some common questions on what the enhancements mean for both potential KiwiSaver members (including the self-employed) and employers.
KiwiSaver members
Q What Budget announcements will be good news to KiwiSaver members?
A KiwiSaver members will benefit from the Government’s Budget announcements. In addition to the $1,000 ‘kickstart’ Government payment for all individuals joining KiwiSaver, KiwiSaver members will be entitled to:
a matching Government ‘tax credit’ for member contributions to KiwiSaver of up to $20 per week – from 1 July 2007;
a matching employer contribution for member contributions to KiwiSaver of up to 4% of an employee’s gross salary or wages – phased in over four years and commencing from 1 April 2008;
an annual Government KiwiSaver fee subsidy of $40 – from 1 July 2007; and
a 30% tax rate cap on KiwiSaver scheme income – from 1 April 2008.
Q I’m on the 39% marginal tax rate. How does the 30% tax rate cap on KiwiSaver scheme income work?
A The Budget announcement to lower the company tax rate from 33% to 30% applies to certain other entities, including Portfolio Investment Entities (PIEs) and widely held savings vehicles.
The maximum rate of tax that a KiwiSaver member will pay on income generated from their interest in the KiwiSaver scheme is 30% – even if their marginal tax rate is 33% or 39%.
Tax paid on KiwiSaver scheme income is generally a ‘final tax’ and is not required to be included in a KiwiSaver member’s annual income tax return.
Q Do the employer contribution tax exemption and first home subsidy that existed prior to the Budget remain?
A Yes and yes.
KiwiSaver members who are employees will still be eligible for the ‘capped’ exemption from specified superannuation contribution withholding tax (SSCWT) for employer contributions.
Some KiwiSaver members who are first home buyers will be eligible for a housing deposit subsidy of $1,000 per year of saving, up to $5,000 in total.
The eligibility criteria are set by Housing New Zealand and will include household income and regional house price caps.
Q What about ‘mortgage diversion’? Is this still possible?
A Yes, it is. After one year of KiwiSaver membership, members will be able to divert up to half of their own contributions to make mortgage payments on their principal place of residence.
If you use the mortgage diversion facility, the portion of your contributions that are diverted will not be eligible for the Government’s member tax credit of up to $20 per week.
Q Before the Budget announcements, my employer agreed to contribute half of the 4% minimum contribution that I am required to make to KiwiSaver. In effect, this meant I only had to contribute 2% of my gross salary. Is this still possible?
A Yes. Until 1 April 2011, employer contributions can count towards an employee’s minimum KiwiSaver contribution for arrangements entered into before 1 April 2008.
Transitional rules apply to phase out such arrangements so that, from 1 April 2011, the minimum employee contribution will be 4% of the employee’s gross salary or wages.
Note also that the employer contributions will be exempt from SSCWT, up to the lesser of the member’s contribution or 4% of the member’s gross salary or wages (announced in August 2006).
Q My employer already offers a superannuation scheme to staff and contributes into it on my behalf. I would like, however, to take advantage of some of the KiwiSaver incentives such as the Government’s member tax credit. Can I join KiwiSaver?
A Yes, you can. If you choose to become a KiwiSaver member, your employer must enrol you and must make KiwiSaver deductions from your pay on your behalf. You will then be eligible for the member tax credit.
Your employer may be required to contribute also to your KiwiSaver account from 1 April 2008. Your employer’s contributions to an existing superannuation scheme count towards their compulsory contribution in certain circumstances.
Employers of KiwiSavers
Q As an employer, I understand that I must contribute to my employees’ KiwiSaver accounts. How much must I contribute?
A From 1 April 2008, employers must match their employees’ contributions to KiwiSaver.
The compulsory contributions will be phased in over four years – starting at 1% of an employee’s gross salary from 1 April 2008 and rising to 4% by 1 April 2011.
This means that employers must make KiwiSaver contributions for each employee who is a KiwiSaver member and is making employee contributions to their account.
Employers are not required to contribute to those employees who are KiwiSaver members but are not contributing to their KiwiSaver account – eg those on a ‘contributions holiday’.
Q I have four employees who will become KiwiSaver members. Their respective salaries are $45,000, $55,000, $60,000 and $85,000. All have decided to contribute 4% of their gross salary, except the one earning $80,000, who has elected to contribute 8%. How much must I contribute to each employee’s KiwiSaver account?
A The level of matching contribution that you must make as an employer is limited to 4% of an employee’s gross salary. As an introductory measure, the level is set at 1% for the year beginning 1 April 2008 and increases 1% a year thereafter to 4% by 1 April 2011, as follows:
Q These contributions will come as an extra cost to my business. How does the Government expect me to cover this cost?
A From 1 April 2008, the Government will allow a tax credit to employers making compulsory contributions to their employees’ KiwiSaver accounts. The contribution will be up to $20 per week per employee and will be paid through the PAYE system to minimise the impact compulsory contributions will have on employers’ cashflow.
The credit will fully offset the cost of compulsory employer contributions on an employee’s salary or annual wages of up to:
$104,000 in the year beginning 1 April 2008;
$52,000 in the year beginning 1 April 2009;
$34,000 in the year beginning 1 April 2010; and
$26,000 in the year beginning 1 April 2011.
Employers must bear the cost of compulsory contributions in excess of the $20 per employee per week tax credit. Note that employers who are taxpayers will be entitled to a deduction for compulsory contributions to the extent that they exceed the employer tax credit received.
The Government expects that employer contributions may form part of the employee remuneration negotiation process in years when the cost to employers of compulsory contributions exceeds the credit.
KiwiSaver and the self employed
Q I am self-employed. Can I enjoy the new benefits that KiwiSaver offers?
A The self-employed, including sole traders and partners in partnerships can join KiwiSaver by contracting directly with a KiwiSaver provider.
The self-employed will:
receive the $1,000 kickstart Government payment;
receive the annual Government fee subsidy of $40; and
be eligible for the matching tax credit for KiwiSaver members of up to $20 per week.
Shareholder-employees of close companies that derive salaries or wages from these companies that are subject to the PAYE rules and who join a KiwiSaver scheme will receive compulsory employer contributions. In addition, their employers will be entitled to the employer tax credit.
Shareholder-employees deriving salaries or wages that are not subject to the PAYE rules are not subject to the compulsory enrolment rules. Nor do the compulsory employer contributions apply should they ‘opt in’ to KiwiSaver. All contributions for such individuals will be voluntary.
Corporate tax rate change
From the beginning of their 2008-2009 income years companies and certain other entities will be taxed at 30%.
Early balance date companies will have an advantage over standard and late balance date companies. For example, a 31 October balance date company will be subject to the new 30% rate from 1 November 2007 whereas a 30 September balance date company will not be taxed at the new 30% rate until 1 October 2008.
The new rate is likely to encourage some business owners who currently operate as sole traders or partners and some trading trusts to consider changing to a corporate model.
There may be some legitimate opportunities for businesses to defer income until after the 30% rate is introduced or incur expenditure earlier than they might otherwise have done to ensure they can deduct it at the 33% rate.
The rate reduction has required a multitude of amendments to the tax legislation. Most of the amendments apply from the beginning of taxpayers’ 2008-2009 income years. The exceptions are those that relate to:
benchmark dividends, which are to apply from 1 October 2007; and
qualifying company election tax (QCET), which apply from Budget day.
Provisional tax
Special rules have been introduced for provisional taxpayers who use the uplift method. The standard uplifts of 105% (of the previous year’s residual income tax (RIT)) and 110% (of the year before the previous year’s RIT) are reduced to 95% and 100% respectively.
Imputation
The imputation ratio will change to 30/70 from 1 April 2008 but the current ratio of 33/67 will be available until 31 March 2010 for the distribution of profits taxed at 33%. This will ensure that shareholders are not adversely affected when dividends are paid out in arrears. At the end of the transition period companies will be able to distribute any 33% tax credits but it will be at the new imputation ratio of 30/70.
Other consequential changes to be aware of include:
from the beginning of the 2008-2009 income year, corporate shareholders will receive only a 30% tax credit for imputation credits attached to dividends received when the dividends are imputed at 33/67. However, they will still receive a full 33/67 credit to their imputation credit account.
the resident withholding tax (RWT) rate will remain at 33%, so imputing at 30/70 will result in 3% having to be deducted as RWT. However, the Government has announced that the RWT rates are under review.
BETA and conduit tax relief credits / debits will receive a 3% 'haircut' from the beginning of the 2009 income year. This reflects the fact that, when the credits are used the applicable tax rate will be 30%.
a new foreign investor tax credit (FITC) formula will apply when dividends are imputed at 30/70. This will still result in a FITC equal to the supplementary dividend. The 33/67 FITC formula continues for dividends imputed at 33/67.
Deferred tax balances
Companies will need to analyse their deferred tax balances to take into account the new tax rate. The implications are as follows:
for periods ending before 17 May 2007 (the date the new tax rate was announced) ie effectively for periods ending 30 April 2007 or earlier, companies cannot recalculate their deferred tax balances using the 30% tax rate (ie they must calculate the balances using 33%). Where the effect is material, it should be disclosed in the current year’s accounts as a post balance date event that has not been adjusted for;
for periods ending between 18 May 2007 and 30 September 2007 (ie effectively for May – September balance dates) companies will need to analyse the deferred tax balances to distinguish between those components of the balances that will reverse in their 2007-2008 income year (to be calculated at 33%) and those that will reverse in subsequent years (to be calculated at 30%); and
for periods ending from 1 October 2007 onwards, the deferred tax balance will need to be calculated using the 30% rate.
Where possible, companies with deferred tax assets should consider reducing temporary differences prior to the 2008-2009 income year by, for example, writing off as many bad debts as possible and disposing of obsolete stock and/or fixed assets as this would reduce the impact of the change in the corporate tax rate on the level of tax expense.
R&D tax credits
Businesses throughout New Zealand are working through what last week’s announcement of research and development (R&D) tax credits amounting to 15% of eligible expenditure will mean for them. The proposals already affect a number of core business activities including decisions around ownership and participation in R&D activities, 2008/ 2009 R&D budgets and planning for the necessary system changes.
Our Budget 2007 Tax Analysis gave a high level outline of the R&D tax credit proposals. We now examine the general eligibility criteria and the definition of R&D. This is the first in a series of articles we will publish providing further analysis of the proposals and how they can be applied by taxpayers.
Definition of R&D
Although similar to the Australian definition, the proposed definition for New Zealand is intentionally broad. It is expected to apply to a wide range of development activities in a variety of industries. In order to qualify, businesses must satisfy the general eligibility criteria and conduct eligible R&D activities.
General eligibility criteria
With the exception of industry research co-operatives, the claimant must be in ‘business’ and the expenditure for which a claim is made must relate to that business. A business exists where there is an undertaking carried on for pecuniary profit which includes the tax exempt and those making losses. The business must be carried on through a fixed establishment in New Zealand. Crown Research Institutes, District Health Boards and their associates (using the expanded test for association rather than the general test) or entities controlled by them are not eligible for R&D credits;
The business must spend at least $20,000 unless the R&D project is outsourced to a listed research provider;
The business must bear the financial and technical risk, have control over the R&D work and own the project results. However, there is no requirement for the business to own the intellectual property created, or to continue to own the project results and sharing the results is allowed;
The R&D must be conducted predominantly in New Zealand; and
All types of New Zealand businesses are eligible, whether incorporated or not, including businesses that earn only exempt income.
Businesses will be able to approach the Commissioner for a determination on eligibility. The Commissioner will be able to determine whether:
an activity meets the new definition of ‘research and development activities’;
a person meets the eligibility requirements; and
the expenditure or depreciation loss meets the new definition of ‘eligible amount’.
It will not be possible to seek a binding ruling on the matters listed above.
Eligible R&D activities
Businesses need to realise that the R&D tax credits will be available for more than just basic ‘white coat’ scientific research. The research efforts also do not need to be successful. The definition is set out in the terms of core qualifying activities with certain supporting activities being counted as well. For the purposes of the regime there will be new definitions for ‘research and development’, ‘research and development activities’ and a ‘research and development project’.
The core qualifying activities must be systematic, investigative and experimental. They must either seek to resolve scientific or technological uncertainty or involve an appreciable element of novelty and be directed at acquiring new knowledge or creating new or improved products or processes. Improvements to products and processes are permitted but the activity must be more than just a routine upgrade.
Supporting activities that are required for, or are integral to, carrying on the core R&D activity can also be eligible.
Systematic, investigative and experimental
R&D activities must be systematic, investigative and experimental. Claimants will need to demonstrate that the R&D process followed a planned, logical progression of work involving hypothesis, experiment, observation and evaluation. From the Australian experience, this is a compound phrase where each of the terms bears upon the other two terms, and activities should possess overall the attributes or character of systematic, investigative and experimental activities. It is important to establish that experimental activities have been undertaken within the projects or activities.
To determine whether an activity is experimental, the Australian experience tells us that:
tests should be undertaken to discover something unknown, to test a hypothesis or to find something out. They have not simply been done to confirm something already known or to demonstrate an already known fact except where the information is not available on normal commercial terms;
businesses should be able to describe the experimental activities, what the outcomes were, and how the experiments were undertaken; and
businesses should be able to provide documentary, and where possible, physical evidence of the experimental activities – including records of the testing regime and the outcomes and evaluation of the experiments.
Scientific or technological uncertainty
Scientific or technological uncertainty relates to uncertainty concerning the possibility of a thing or its achievement in practice. The uncertainty could be due to the knowledge not being:
publicly available; or
deducible by a competent professional working in the field.
Appreciable element of novelty
Novelty means a development by comparison with public knowledge of the technology on a reasonably accessible worldwide basis. Therefore, R&D activities carried out simultaneously by independent parties can qualify, as will replicating work that has been done previously where that work is not available on commercial terms.
The “appreciable element of novelty” limb is also drawn from the Australian R&D model. The Australians take ‘new’ to be of novel character, different to things known or seen before. To establish whether something is new or different, they compare it with what was already available in the public arena on a reasonably accessible world wide basis at the time. They do not consider that the production of a new product, device or process, by itself, would qualify the activities as being novel (but the process development may well qualify as novel), nor is it sufficient for a product to be the first of its type by the claimant or even the first of its type in the country. The Australian regime also does not require the claimant to seek a patent.
Activities that are not eligible as a core activity include:
research in social sciences, the arts or humanities;
commercial, legal and administrative aspects of patenting/ licensing;
complying with statutory requirements or standards;
management studies or efficiency surveys;
prospecting/ exploring/ drilling for minerals/ petroleum/ gas etc;
reproduction of a commercial product or process by a physical examination of an existing system or from plans/ blueprints/ detailed specification or publicly available information; and
pre-production activities such as demonstration of commercial viability, tooling-up and trial runs.
However, some of these activities may qualify if they support another core activity. For example, market research on the taste acceptability of, and preferences for, a brand new food product would be eligible.
The key message is that businesses should not think narrowly about what activities are eligible for the credits. They should consider carefully all of their current activities in light of the definitions.
Better incentives for charitable giving
Changes to the tax rules governing charitable giving announced in Budget 2007 are included in the May Bill. The changes are aimed at encouraging philanthropy in New Zealand.
Under the new rules:
individual donors will be able to claim a 33 1/3% tax rebate on all donations up to their annual net income; and
companies (including unlisted close companies) and Maori authorities will be able to claim a tax deduction for donations up to their annual net income.
The positive impact of the changes is illustrated below. From 1 April 2008:
an individual with net income of $100,000 who makes charitable donations of $3,000 will receive a rebate of $1,000 - substantially more than the current rebate entitlement of $630; and
a company deriving net income of $200,000 (before taking into account donations) that makes charitable donations of $20,000 over the income year will be entitled to deduct the full $20,000. Under the current rules the deduction is limited to $10,000 ie 5% of $200,000.
Penalties
The Bill gives effect to the proposals set out in the Government’s Discussion Document, ‘Tax penalties, tax agents and disclosures’, released in October 2006. We welcome the proposed changes to the tax penalties regime. They should achieve their aim of encouraging voluntary disclosures and compliance.
Shortfall penalties Voluntary disclosure
The Bill increases incentives for a taxpayer to comply voluntarily and avoid shortfall penalties for not taking reasonable care or for taking an unacceptable tax position if the tax shortfall is voluntarily disclosed before the taxpayer receives notification of a tax audit or investigation.
Currently shortfall penalties may be reduced to 75% where a taxpayer voluntarily discloses a tax shortfall in such circumstances and to 40% if disclosure is made after the taxpayer receives notification of a tax audit or investigation.
The Discussion Document originally proposed a two year limit on the non-application of shortfall penalties. However, given that the time bar provisions provide a window of four years in which to make a disclosure, the two year time limit has been removed. The rationale is that taxpayers are more likely to disclose tax shortfalls voluntarily if there is no time limit.
To avoid taxpayers refraining from making voluntary disclosures until after the legislation is enacted, the new rules will apply from 18 May 2007, the day after the Bill was introduced.
Reasonable care
Generally, taxpayers who have relied on tax agents are considered to have exercised reasonable care. The IRD’s current practice is to impose shortfall penalties where a taxpayer:
fails to provide adequate information when seeking advice;
fails to provide reasonable instructions to a tax agent; or
unreasonably relies on a tax adviser or on advice that they have reason to believe is not correct.
The Bill includes these circumstances in the legislation and extends them to include circumstances where a taxpayer has had a previous tax shortfall penalty imposed for the same error or action.
From a practical perspective, it will be necessary for both taxpayers and the IRD to maintain accurate records as to when a previous tax shortfall penalty has been imposed for the same error or action. The phrase “same error or action” should also be clearly defined in the legislation.
We are generally supportive of these changes but are unsure how the term “adequate” will be interpreted by the IRD, as this is not a defined term. In other areas of law, “adequate” is defined with reference to what a reasonable person would do in the same circumstances. If a taxpayer’s tax position is complex, “adequate” instructions and information may need to be more comprehensive than if the tax position is straight forward.
Unacceptable tax position
The Bill amends the rules relating to the unacceptable tax position shortfall penalty. Currently the penalty is imposed where the tax shortfall is more than both:
$20,000; and
the lesser of 1% of the total tax figure and $250,000.
The Bill increases the threshold so that the penalty applies only if the shortfall is greater than:
$50,000; and
1% of the taxpayer’s total tax figure for the relevant return period.
The new rule should ensure that the penalty does not apply to smaller transactions undertaken by large taxpayers. We consider the 1% threshold is still too low.
The Bill also removes GST and withholding taxes from the scope of the unacceptable tax position shortfall penalty.
Abusive tax position
The Bill repeals the threshold for imposing an abusive tax position shortfall penalty. Currently an abusive tax position shortfall penalty of 100% of the tax shortfall is imposed where the tax shortfall is more than $20,000. Under the new rules, the IRD will be able to impose the penalty regardless of the amount of the tax shortfall. However, the penalty will continue to be aimed at tax positions that have a dominant purpose of reducing or removing a tax liability or providing tax benefits.
Late filing penalties PAYE
The Bill clarifies that when an employer monthly schedule for PAYE is filed late the employer will be given a warning. If the employer is late in filing the schedule again, late filing penalties will be imposed without any further warning. This change reflects the IRD’s current practice and provides some certainty for taxpayers.
GST
Under the new rules, a late filing penalty will be introduced for GST returns that are not filed by the due date. Where a taxpayer accounts for GST on an invoice basis, a $250 late filing penalty will be imposed. A $50 penalty will be imposed where a taxpayer uses a GST payments basis.
This change replaces the IRD’s current practice of issuing default assessments, which can be an excessive response to non-filing, as the default assessment is usually higher than the actual GST liability. The default assessment process will be maintained for significant or ongoing non-compliant behaviour.
Late payment penalties
Under the new rules, rather than imposing an immediate late payment penalty, the IRD will notify a taxpayer the first time their payment is late. If payment is not made by a certain date, a late payment penalty will be imposed.
Taxpayers will be entitled to only one ‘first chance’ notification every two years. After receiving a first warning, the IRD will not send further notifications for two years and an initial late payment penalty will be imposed in the normal manner.
This change is an improvement on the current rules, whereby a 1% penalty is imposed on overdue tax the day after the tax is due, a 4% penalty is imposed on the sixth day, and a 1% penalty is imposed for each month the tax remains outstanding.
The new rules are lenient on taxpayers who inadvertently miss a payment but are usually compliant. The effectiveness of the ‘first chance’ notification will depend on the IRD maintaining accurate records of when it issues warning letters to taxpayers notifying them the first time their payment is late.
All taxpayers will have the opportunity to start with a clean slate from 1 April 2008.
Tax amnesties
The Bill provides the IRD with the power to offer limited amnesties to specific industries where tax evasion is a significant concern.
The terms of the amnesty offer will:
specify the taxes that are included in the amnesty and the period in which tax evaders can come forward; and
clearly communicate that investigations and audits of the targeted industry will begin after the amnesty expires.
The amnesty will apply only to income from the specific industry. The overall determination of the taxpayer’s liability will include use of money interest, shortfall penalties and any consequential effects of disclosing income for family assistance, student loans and child support liabilities. Shortfall penalties will be reduced to 75% for voluntary disclosure and 50% for previous good compliance.
The IRD’s power to offer amnesties will apply from the date of the Bill’s enactment.
