21st January 2011
Welcome to our first update for 2011. In this update, we will look at the implications of some of the key events of last year and also ahead to several forthcoming developments in what is an election year and also the Chinese Year of the Rabbit.
2010 “The times they are a changing”
In the tax world change is a constant and this was never truer than of 2010. It was one of the more dramatic years in tax we’ve experienced in over 25 years of practice.
There was the first increase in the rate of GST in 21 years, significant income tax cuts for individuals and companies, a sweeping overhaul of the depreciation rules for property investors, the replacement of the Qualifying Company and Loss Attributing Qualifying Company regimes, the abolition of Gift Duty and a number of controversial court decisions.
The increase in the rate of GST from 12.5% to 15% is something which really does affect everyone in New Zealand. Unfortunately for the Government, the hope that the impact of the increase would be more than offset by the personal income tax cuts appears to have been stymied by factors such as rising world food and oil prices and the massive floods in Queensland. As a result there is growing pressure for New Zealand to follow many other jurisdictions and apply a zero rate of GST on some foods, principally “fresh fruit and vegetables”. This is an issue we anticipate will be vigorously debated during this year’s General Election.
The reduction in individual income tax rates was generally widely welcomed. Longer term we consider the key change will be the re-alignment of the top individual income tax rate (33%) with that of trusts. This has removed the ability to arbitrage tax rates, and through use of trust structures mitigate the effect of the former 38% top rate (a central fact in cases such as Penny and Hooper v Commissioner of Inland Revenue).
The headlines regarding the GST increase and income tax cuts overshadowed the significant changes to depreciation and the Qualifying Company and Loss Attributing Qualifying Company regimes also announced in last year’s Budget. The legislation implementing these reforms was finally passed prior to Christmas and they will generally take effect from 1st April 2011.
Also coming into force on 1st April are new GST rules regarding the zero-rating of land transactions and the calculation of GST input tax in respect of goods and services used for exempt and taxable purposes.
Over the next few updates we will comment on these changes in more detail and how they will affect you.
Going, going, gone
The Government has abolished Gift Duty with effect from 1 October 2011 noting that it collected minimal revenue ($1.6 million in 2009/10) but imposed compliance costs estimated to be over $70 million. Gift Duty’s abolition therefore seems a logical step but it has not been universally welcomed. In particular, lawyers involved in property relationship matters fear that Gift Duty’s abolition will diminish the rights of claimants under the Property Relationship Act 1976 by encouraging greater use of trusts.
The abolition of Gift Duty also means that New Zealand is one of the few developed world jurisdictions without any form of generally applicable capital taxation such as a capital gains or wealth tax. This leaves a potentially large hole in the New Zealand tax base which in our view is unsustainable in the long term. We will look at this in more detail in a future update.
In the Courts: Commissioner of Inland Revenue 3, Taxpayers 0
There were three important tax decisions in the courts during 2010 all of which were decided in favour of the Commissioner of Inland Revenue. In the GST case of Contract Pacific Limited v Commissioner of Inland Revenue the Supreme Court held that so long as the Commissioner gave an initial notification of investigation of a GST refund claim within 15 working days of receipt, then the refund could be held indefinitely until the investigation was concluded. We consider this to be a very disappointing decision because it effectively removes the incentive for the IRD to process GST refunds promptly. It therefore tips the balance too heavily in favour of the Commissioner. Along with other tax professionals we have asked the Minister of Revenue to introduce a statutory amendment to clarify the position.
Property developers are never the most popular figures so it’s doubtful whether many people shed too many tears over the High Court decision in Krukziener v Commissioner of Inland Revenue which effectively bankrupted the well known developer Andrew Krukziener. Following an investigation begun in 1999 covering the period from 1991 to 2002, the IRD concluded that Krukziener’s practice of drawing loans against the future profits of a development represented tax avoidance. The sums totalling over $5 million drawn by Mr Krukziener during the period under investigation should therefore be re-classified as income. In 2009 the Taxation Review Authority upheld the IRD’s argument in TRA Case Z23, and in September 2010 the High Court rejected Mr Krukziener’s appeal. Courtney J held that the TRA was correct in holding that a tax avoidance arrangement existed.
We have several concerns with this decision; firstly, the classification of loans as income runs contrary to generally accepted accounting practice. Secondly, it is quite common practice for proprietors to have overdrawn current accounts during the initial years of their business. Unfortunately, neither the Taxation Review Authority nor the High Court gave any guidance as to when the practice would represent tax avoidance. Without further clarification a large number of individuals with overdrawn loan accounts could be affected. Finally, the fact that the High Court hearing took place more than 10 years after the investigation began raises serious questions about the entire Disputes Resolution Process. Justice delayed is justice denied even if it involves a property developer. We have taken this issue up with the Minister of Revenue and we will advise you in a future update of any developments in this area.
In June 2010, the Court of Appeal by a 2:1 majority overturned the High Court decision of Penny and Hooper v Commissioner of Inland Revenue (see http://baucherconsulting.co.nz/news7.html). This has been one of the most closely followed cases in recent years because the structures involved are very common. Consequently, like the Krukziener case the implications are potentially very far reaching. The taxpayers appeal before the Supreme Court was heard late last year and the judgement is expected very shortly.
Based on the recent decisions of the Supreme Court we do not believe the taxpayers’ appeal will be successful. Regardless of the outcome, we hope the Supreme Court will take the opportunity to set out some clear principles on what constitutes tax avoidance as the position is now very unclear particularly in the wake of the Krukziener decision. We will brief you on the Supreme Court’s decision in a future update.
2011 – The Year of the Rabbit?
2011 will be the Chinese Year of the Rabbit, which seems rather appropriate given it is an election year. However, the economy’s weak growth together with continuing budget deficits makes it unlikely that the Government will be able to pull many rabbits out of the tax hat before the election. This will perhaps be of some relief to taxpayers and their advisors in general, as absorbing and responding to the many changes made in 2010 will take time.
No doubt the law of unintended consequences will result in several tax rabbits popping up somewhere during 2011 and we will keep you updated on the latest tax developments as the year unfolds.
In the meantime please contact Terry Baucher on 09 486 6200 for more detailed advice on the Budget and its implications for you.
Regards,
Terry Baucher
Director
