June 2009

WHAT YOU’LL FIND IN THIS ISSUE

1. Budget 2009 - The Road to Recovery                                        

2. Income Tax Rates and other Tax Rates from 1 April 2009

3. Government Tax Policy Programme

4. Deferral of Application Dates - Taxation Bill

5. Student Loan Early Repayment Incentive

6. Payments made by Parents or Guardians of Students to State Schools - GST Treatment

7. Mileage Rate for Expenditure incurred for the Business use of a Motor Vehicle

8. OCR - No Change in June Announcement

9. Specified Livestock Determination

10. Repairs & Maintenance and Capital Limitation

11. QC Dividends Paid to Beneficiaries of a Trustee Shareholder

12. RWT on Payment of Dividends in Transitional Period

13. General Partnerships - Taxation

14. Transfer of Business - Tax Avoidance

15. Shareholder Paying a Loss Company a Contract Fee - Tax Avoidance

16. News about the Office

1. BUDGET 2009 – THE ROAD TO RECOVERY

The major announcements in the 2009 budget stem from the government’s objective - to take steps to keep government debt under control.

The overriding concern of the government was that current debt levels put New Zealand at risk of an adverse reaction from overseas investors and rating agencies, which would in turn result in increased borrowing costs for all. Standard & Poor’s immediately responded to the release with an announcement that NZ maintains it’s AA+ credit rating and moves to a stable footing from a negative outlook.

The budget introduces a number of measures to contain government debt and those include:

• reprioritising government expenditure and reduction in operating allowances in the 2010 year with modest increases over the next 4 years;

• a delay in the personal income tax cuts scheduled for the 2010 and 2011 years and the associated increase in Independent Earner Tax Credit; and,

• suspension of automatic contributions to the New Zealand Superannuation Fund.

There are indications that major tax changes are still to come. The reference to the Tax Policy Work Programme announced in March 2009 to consider the medium term direction of the tax system, and the formation of the Tax Work Group in May 2009, indicates a commitment to a review of the tax system and significant tax reforms in the future. The Tax Working Group has recently indicated the prospect of capital gains tax on property transactions.

KiwiSaver mortgage diversion will cease and there will be changes to PIE and RWT rates to align with tax rates. The KiwiSaver mortgage diversion facility will not be available to new applicants from 1 June 2009. Mortgage diversion is a feature of KiwiSaver that allows members to divert up to half their contributions to their mortgage repayments. The scheme has been little used since the inception of KiwiSaver. Only 600 people have taken it up and it is likely that the government has removed it for reasons relating to savings in compliance costs.
The suspension of contributions to the New Zealand Superannuation Fund will impact on the build-up of funds to satisfy the expected demands of that fund in the future. The government says in the budget that future funding is locked into the Government’s long-term spending path and the suspension of contributions will not affect people’s entitlements. New Zealand Superannuitants will continue to be paid at a minimum 66 percent of the average wage from the age of 65. 

2. INCOME TAX RATES AND OTHER TAX RATES FROM 1 APRIL 2009                                        

 

Income Tax

The income tax rates for individuals from 1 April 2009 are summarised in the following table:



The provisional tax payments for the 2010 year will be based on 105% of the residual income tax for the 2009 year less $730, and 110% of the residual income tax for the 2008 year less $1,460 for individuals. The rate will depend on whether the tax return for the 2009 year is filed by the provisional tax payment date.

The GST ratio method applies a factor 90% to the calculation of 2010 provisional tax. The provisional tax payments for the 2010 year for companies will be 100% of 2008 and 105% of 2009 residual income tax, and for trusts 105% and 110% respectively.

Secondary Tax Codes

The secondary tax codes for individuals from 1 April 2009 are summarised in the following table:

Independent Earner Tax Credit

The Independent Earner Tax Credit will remain at $10 each week for eligible taxpayers that earn annual net income between $24,000 and $44,000, and for those that earn more than $44,000 the entitlement will reduce by 13c for each additional dollar earned. Eligible taxpayers are tax residents that do not receive Working for Families Tax Credits, income tested benefits, NZ Superannuation, a veteran pension or foreign equivalent of any of those benefits. PAYE earners need to complete a new tax code declaration form to receive the credit and self employed will receive it as a lump sum for the year ended 31 March 2010.

FBT Rates

The new FBT flat rate changed from 64% to 61% from 1 April 2009 and the new multi-rates for the 2010 year are summarised in the following table:

Lump Sum Payments

Tax withheld on lump sum payments to employees as extra pay will depend on the employee’s annualised income. The new rates and thresholds from 1 April 2009 are summarised in the following table:



We recommend that staff who receive lump sum payments during the year request a personal tax summary to ensure PAYE has not been over-deducted.

RECENT GOVERNMENT RELEASES 

3. GOVERNMENT TAX POLICY PROGRAMME 

On 20 March 2009, the Government announced its tax policy work programme for 2009-10. The focus of the new work programme is on better positioning New Zealand in the world economy and maintaining tax revenue in a time of global economic crisis. The programme outlines separate projects in a wide range of areas of tax including:

• Alignment of personal, company and trustee tax rates at 30%.

• Income splitting of household income between two people.

• Increase tax incentives for charitable giving and inclusion of nonmonetary gifts.

• Review of the imputation regime and in particular the issue of streaming of imputation credits and alignment of credits with Australia.

• Review of the operations of the IRD and efficiencies within that department.

• Policy changes to the treatment of use of money interest, provisional tax, disputes resolution process and deductibility of capital expenditure.

These will be the topic of ongoing public news and debate in the coming months.

4. DEFERRAL OF APPLICATION DATES - TAXATION (INTERNATIONAL TAXATION, LIFE INSURANCE, AND REMEDIAL MATTERS) BILL 

The Bill was introduced to Parliament in July 2008, and is with the Finance and Expenditure Committee and not expected to be tabled back in Parliament before August 2009. The Minister has written to the chairman outlining his concerns and asking the committee to defer the proposed application dates of a number of reforms.

The application dates of most concern are those for the reforms relating to the international tax rules, the taxation of the life insurance business, definitions of associated persons, and payroll giving for charitable donations.

• The international tax changes provide for the first stage of reforms to New Zealand’s international tax rules, and proposes changes to the Controlled Foreign Company (CFC) regime to reduce the existing grey list to Australia only. The intention is to provide a level playing field to those who have invested in companies outside of the eight grey list countries who are required to attribute CFC income to New Zealand. The change will mean that a number of taxpayers will need to consider the CFC regime for the first time. The Bill provides a concession to the CFC rules for “active income”. Shareholders in CFCs will only be required to pay tax on “passive income” attributed to New Zealand. Tax will be paid on “active income” when that income is repatriated to New Zealand by way of dividends, interest and royalties. The Minister has recommended that the application date remain at the 2009/10 income year only for taxpayers who have balance dates on or after 30 June 2009, the date the Bill is expected to be reported back to Parliament. For all other changes, the application date would be the 2011 income year.

• The reform of the rules on taxing the life insurance business propose to tax life-risk business on actual profits in a manner similar to the way other businesses are taxed, and extend tax benefits of the portfolio investment entity (PIE) rules to all savers in life products. The new rules tax life insurers on two bases, the shareholder base (representing income derived for the benefit of shareholders) and the policyholder base (representing income derived for the benefit of policyholders). The Minister has recommended that the application date of the new rules be deferred until a date to be determined following further discussion with the industry.

• The changes to the associated person rules aim to strengthen and rationalise the    definitions of “associated persons” in the Income Tax Act 2007. The definitions are mainly used in an anti-avoidance capacity to counter non-arm’s-length transactions that could undermine the intent of the income tax legislation. The new rules introduce aggregation rules that associate two companies that have related party shareholders where each has more that 50% ownership or control of one of the companies. The rules will have a significant effect on trust structures, and accordingly structures that use trusts are most at risk. The most burdensome provision is the new tripartite test which associates two persons if each are associated with a third person (ie if A is associated to B and B to C then A is associated with C). There is a new person/trustee test to include spouse, de facto or civil union partner, or infant children (including adopted) that have benefited or are eligible to benefit, a new trustee/settlor test to include the settlor or person with power of appointment or removal of trustees, and a new two trustee with a common settlor test to include both trusts. It reduces the degree of blood relationship from four to two degrees, but includes married persons or persons in civil union or de facto relationships with the effect of the test passing through two degrees of those relationships. The Minister has recommended a one-year deferment, to the 2010/11 income year, except for land provisions, which would be deferred from 1 April 2009 to the date of enactment.

• Payroll giving introduces a voluntary payroll-giving scheme that will allow employees to make regular payroll donations from their pay to charitable organisations of their choice. It is available to employers that electronically file the monthly PAYE schedules. It will also enable employees to receive the tax benefit of their payroll donations each payday, in real-time, without the need to have donation receipts. The employees are rebated at 33 1/3%. People who make donations other than through payroll-giving will continue to claim the charitable donation tax credit at the end of the tax year. The Minister has recommended that the application date be deferred from 1 April 2009 to three months after enactment. 

5. STUDENT LOAN EARLY REPAYMENT INCENTIVE

The Student Loan Scheme (Repayment Bonus) Amendment Bill was tabled in Parliament on 27 April 2009. It introduces a new 10% bonus for all student loan borrowers who make early voluntary repayments of $500 or more on their student loans in a tax year. While the legislation is expected to be enacted by the end of 2009, the bonus will apply to eligible voluntary payments made from 1 April 2009.

6. PAYMENTS MADE BY PARENTS OR GUARDIANS OF STUDENTS TO STATE SCHOOLS – GST TREATMENT 

 

Payment of amounts (whether described as “school fees”, “activity fees” or otherwise) by parents or guardians of pupils, who are New Zealand citizens or New Zealand residents and who are enrolled at state schools (including integrated schools), to the general fund to assist with meeting school costs other than the supply of education are not taxable supplies for GST purposes. Therefore, GST is not payable on such amounts. Other services, not integral to the supply of education services but provided on the basis that payment will be made for such services are taxable supplies and GST is chargeable in those circumstances.

7. MILEAGE RATE FOR EXPENDITURE INCURRED FOR THE BUSINESS USE  OF A MOTOR VEHICLE  

The IRD has set the mileage rate for motor vehicles at 70 cents per kilometre from 1 April 2009.

The mileage rate applies to self-employed taxpayers that travel up to a maximum of 5,000 kilometres of work-related travel each year by motor vehicles irrespective of engine size or whether they are powered by petrol or diesel. They may also be used as a reasonable estimate by employers reimbursing employees for business use of an employee’s vehicle, and shareholder employees without limitation of kilometres of work-related travel each year.

8. OCR - NO CHANGE IN JUNE  ANNOUNCEMENT

The Governor of the Reserve Bank Alan Bollard announced no change to the Official Cash Rate (OCR) at 2.5% percent on 11 June 2009. The Reserve Bank indicated that there are signals that the New Zealand economy will show growth toward the end of this year but recovery is likely to be slow. There has been concern leading up to the announcement that retail banks have not fully passed on reductions in the OCR rates over the last year and the market has not responded to the effects of recent reductions to levels expected. The rate was at 8.5% same time last year and has seen significant falls over the last 12 months but the economy has shown less sensitivity to recent reductions in the rate. The banks are facing relatively high cost of capital and bad debts and that is affecting their margins. The Reserve Bank did acknowledge that the cuts to the OCR during the past year had passed through to the interest faced by household and businesses more in NZ than most countries.

9. SPECIFIED LIVESTOCK  DETERMINATION

On 15 May 2009, the Inland Revenue Department released the National Average Market Values of Specified Livestock Determination, 2009. The determination applies to specified livestock on hand at the end of the 2009 income year. The schedule indicates significant increases in values across all livestock types. The values are used by taxpayers that apply the Herd scheme method to value livestock, and the increases will not affect the tax assessment for those taxpayers. The increases are treated as a tax-free capital gain.

The National Standard Cost values of Specified Livestock were released 29 January 2009 and those values increased on average by 20%. The increase in stock values will affect the taxable income of livestock owners that use the National Standard Cost method. The election from National Standard Cost to Herd Scheme method requires two years notice so is now not an option to minimise the tax in the 2009 year for the increases. If the trends continue then owners may consider an election this year for the 2012 year.

CLIENT QUERIES - TAX

10. REPAIRS & MAINTENANCE AND CAPITAL LIMITATION

Distinguishing between repairs and maintenance and capital expenditure is often difficult and a case of weighing the facts using a framework of tests and case law to determine whether capital limitations deny tax deductibility. There is a three-stage approach that can assist in determining whether or not certain expenditure is deductible:
• Identify the relevant asset. If this is part of a larger asset, it must be a distinct physical unit capable of operating on its own, albeit that it forms part of the whole.
• Ascertain the nature, extent, and cost of the work undertaken in relation to, or on, that asset.
• Determine whether the work has remedied fair wear and tear (deductible repairs), or whether the asset has been improved, or altered, or so substantially changed that it amounts to a new asset (capital).
The tests can be further refined by considering precedents established in recent case law:
• Whether the act to be done is one that in substance is the renewal or replacement of defective parts, or the renewal or replacement of substantially the whole (Wakeley & Wheeler).
• Expenditure that does no more than restore an asset to an “as new” condition, rather than create a new asset, will be deductible whether this is completed in one income year or over a number of years (Auckland Gas Co). This applies even if the asset is “improved” in the sense of using more modern technology and/or being more efficient by being less susceptible to breakdown (Conn v Robins Bros, but c.f. Western Suburbs Cinemas).
• Expenditure on renewal, replacement, or reconstruction of substantially the whole of an asset goes beyond repair and is non-deductible capital expenditure, even if what was spent may have been less than the cost of on-going maintenance (Wakeley & Wheeler; Auckland Gas Co; Poverty Bay Electric Power). This will also still apply even if the asset gives no greater performance and has no greater life span than that of the replaced asset (Case L68).
• The renewal of major components of the asset, rather than their on-going maintenance, can be indicative of the expenditure falling on capital account (Case N8). An assessment has to be made on whether the work is of sufficient substance to place the expenditure on capital account (Wakeley & Wheeler). Any improvement to the asset will be relevant to that assessment (Auckland Gas Co; Poverty Bay Electric Power).
• In determining whether certain work, possibly comprising repairs and or replacements of a large number of component parts, is capital or revenue in nature, it is important to ascertain the taxpayer’s overall intention, i.e. to repair or to totally improve or reconstruct (Colonial Motors; Sherlaw; Case N8). If the total work is substantial and is intended to produce a different and operationally superior asset, it must be regarded as a capital improvement (Poverty Bay Electric Power).
• Work resulting in a significant increase in the value of the asset, a change in its character or kind, or involving an amount not regularly incurred, is more likely to be capital expenditure (Case N8; Auckland Gas Co; Highland Railways). Similarly, an amount incurred that is substantial in relation to the value of the asset prior to the work is likely to be capital in nature (Case N8).

• In the context of a total project it may be artificial to dissect the work into capital and revenue categories, or to further dissect a purported revenue category into capital and non-capital items. It is necessary to look at the entire asset and see what was there before and after (Case N8; Colonial Motors).
• Some authority exists for the proposition that it is possible to carry out substantial repairs over time, provided they are not part of a wider reconstruction project (Sherlaw).
• No deduction is available for notional repairs (Colonial Motors).

The expenditure is deductible in the year that it is incurred if it can be classified as repairs & maintenance. In a recent case the modernisation of frontage to a commercial building was deemed capital expenditure. The finding was consistent with the IRD Technical Rulings para 20.13.1.9 which provides that shop fronts are part of the building proper. The modernisation of the shop front to take account of changing business conditions normally constitutes work of a capital nature, being something more than a repair or alteration.

11. QC DIVIDENDS PAID TO BENEFICIARIES OF A TRUSTEE SHAREHOLDER

All dividends (other than non-cash dividends not being taxable bonus issues) derived by the trustees from a QC/LAQC in an income year must be distributed as beneficiary income to one or more persons who are not trustees or companies other than qualifying companies. The trust is free to choose which beneficiaries receive the dividends, subject to the trust deed, and trust law.

12. RWT ON PAYMENT OF DIVIDENDS IN TRANSITIONAL PERIOD

Resident Withholding Tax must be deducted from dividends paid from profit derived by a company in the 2009 and 2010 years where there are sufficient credits only to satisfy an imputation ratio of 30:70 at dividend date. RWT must be deducted to the extent the imputation credits are less than 33% unless:
• the shareholder holds an exemption certificate;
• the shareholder is a non-resident (subject to NRWT);
• the payer and the recipient are members of the same group of companies at the time the dividend is paid;
• the company is a qualifying company; or
• the dividend is from a PIE (portfolio investment entity).

These rules apply to dividends paid in the transitional period which is the period 1 April 2008 to 31 March 2010. From 1 April 2010 all dividends will be paid with maximum imputation credits of 30%.

Unlike paying RWT on interest, a company does not need to specifically register in advance as a payer of RWT on dividends. The Inland Revenue will register the company automatically when it submits its payment. The payment must be paid to the Inland Revenue by the 20th of the month following deduction. RWT is deducted when the dividend is paid. It is not deducted at the time the dividend is declared.

13. GENERAL PARTNERSHIPS - TAXATION

The Taxation (Limited Partnerships) Act 2008 introduces the following new partnership rules to the Income Tax Act:


• Income and expenses will flow through to partners on the basis of their partnership agreement.
• Transactions between partners and partnerships (except salary payments) will be treated as being at arm’s length.
• Partners will be required to account for tax upon their exit from a partnership in most circumstances. The exceptions are:

• Partners will generally not need to account for tax upon exit if their profit on disposal of their interests is $50,000 or under
• Partners will not need to comply with the requirement in relation to:
  

a) certain types of depreciable tangible property, if the original cost of any depreciable tangible asset held by the partnership $200,000 or less

b) trading stock if the total partnership annual turnover is $3,000,000 or less in the year of disposal; and

c) certain excepted financial arrangements.

• If an exiting partner has performed a revenue account adjustment on livestock, the incoming partner will be allowed to deduct the amount of that adjustment on a straight-line basis over a five-year period. Separate tax books for livestock will not need to be maintained.
• The new entry and exit rules will be elective for partnerships of five or fewer partners provided no partner has limited liability for the debts of the partnership business.

Partnerships will be required to file returns only where the partnership is a registered limited partnership or carries on a business in New Zealand.

 

RECENT TAX CASES

14. TRANSFER OF BUSINESS - TAX AVOIDANCE


Penny and Hooper v CIR has essentially opened the way for taxpayers to transfer their business to a company or other structure without automatically breaching the tax avoidance rules of the Income Tax Act. Provided the arrangement or structure is not artificial or contrived, and there is commercial justification for the structure, the use of the structure on its own will not amount to tax avoidance.

This is a landmark case against the IRD and involved two orthopaedic surgeons accused by the IRD of paying themselves a salary less than market in order to save tax. Both formed companies and employed themselves, paying out only some of the company’s profits as a salary to minimise their tax with the increase in the maximum personal income tax rate in April 2000 from 33% to 39%.

The Commissioner formed the view that the totality of the arrangements involving the taxpayer and the company constituted a tax avoidance arrangement. It was considered that the essential elements of the arrangement involved the carrying on of the orthopaedic practice using the company structure and the fixing of the salary of the taxpayer at a level below a commercially realistic salary.

The surgeons argued that in neither case is there a tax avoidance arrangement. The two surgeons are employed by their family companies and the tax act does not contemplate any notion of commercially realistic salary concept. They contended that the IRD made up that concept.

The High Court noted that the essence of the Supreme Court’s decision in Ben Nevis Forestry Ventures Ltd v C of IR [2008] NZSC 116 was to endorse a “scheme and purpose” approach. The court said that the inquiry into scheme and purpose was to be conducted having regard to the arrangement as a whole, not to its constituent parts.



Formation of the company

The High Court found that the formation of the company and the conduct of the practice through it was, in commercial law terms, a valid choice of business structure. Furthermore, the Income Tax Act did not support the notion that the income from personal exertion could not be derived by a company. Looking at the scheme and purpose of the Act, the court said that it did not discern any general intention to distinguish between business income, which was the product of personal exertion, and that which was not, so far as its derivation was concerned. Any principle that a particular category of business income could be derived only by individual taxpayers would have to be clearly prescribed in the legislation. The court went on to say that in this case the purpose of the formation of the company was to adopt a normal and permissible structure for the conduct of the business, and the tax effect from that arrangement was merely incidental to that purpose.



Fixing of the salary

The High Court found that there was nothing in the Income Tax Act to support the proposition that in non-arm’s length contracts of employment there is a requirement that the salary be commercially realistic.



The benefit of the money

The IRD produced evidence that in the case of one of the taxpayers, the profits of the company in the relevant period had all been distributed to a family trust, the sole shareholder, as dividends. The cash flows further showed that the after-tax profits of the trust had delivered an increase in net assets of the trust over the relevant years, of which $1.1m had been advanced to the taxpayer for his personal use on a no-interest basis and with no specific repayment terms. The High Court found that the tax applicable to the money flows had been paid. The High Court held that the fact that the taxpayer had the ultimate benefit of the funds was not an indicator of tax avoidance because the scheme and purpose of the Income Tax Act did not require him to receive the ultimate benefit by deriving the funds as personal income.



Overall consideration

After considering the constituent parts of the arrangement, the High Court held that the arrangement, as a whole, was not one which had the purpose or effect of tax avoidance, or, alternatively, if it did so, that purpose or effect was merely incidental to the purpose of adopting the corporate form of practice.

The IRD has announced that it is appealing the decision. The Commissioner does not consider the decision correctly reflects the law on tax avoidance, and that the use of the company and trust structures to avoid higher personal tax rates can be tax avoidance.

15. SHAREHOLDER PAYING A LOSS COMPANY A CONTRACT FEE - TAX AVOIDANCE 

The Taxation Review Authority (TRA) has held that, although there was a commercial purpose to a new business structure put in place by a real estate agent, the business arrangement was not commercial as a whole. It was contrived, and crossed the line into tax avoidance. The TRA found that a fee of $65 per hour, paid to the taxpayer’s company for an administrative assistant’s services, was excessive. It was not a true economic cost, and it enabled the taxpayer to claim over-stated income tax deductions for the fees he had paid his company for supplying the services back to his real-estate business.

The taxpayer carried on business as a real estate salesperson. He employed a part-time assistant (Mrs M) to perform various administrative duties. She was paid $15 per hour. This person also performed real estate duties on a commission basis.

The taxpayer was the sole director of a company and an equal shareholder with his wife. The company had losses brought forward of $192,844.82. On 15 March 2001, the taxpayer entered into a contract with his company for it to supply him with management and administrative services. Under the contract, the taxpayer was obliged to pay the company $60,000 per annum for the provision of 240 days of administrative services. In fact, the company charged the taxpayer an hourly rate of $65.00 plus GST for the services it provided to the taxpayer in the form of Mrs M’s administrative work for him. Mrs M was employed as an independent contractor by the company. Mrs M performed the same duties as she had previously performed for the taxpayer, for the same pay and in the same location. The taxpayer claimed a deduction for the fees paid to the company.
Before the contract, the taxpayer was paying $15 per hour for administrative support, which was within the normal range of fees for such services. During the contact, the taxpayer paid $65 per hour plus GST for essentially the same services.

The IRD considered that the taxpayer had obtained an inflated income tax deduction for the amount they paid the company but did not suffer the full economic consequences. The annual profits of the company were transferred to the taxpayer who received them as capital because they were repayments of a shareholder’s loan by him to the company. As a result, the taxpayer made a profit on the difference between his payments to the company and the payments to Mrs M by the company. Income tax was not paid on the difference.

The IRD treated the taxpayer’s structure as void and income was assessed consequentially to the taxpayer with normal deductions related to the earning of that income. The taxpayer challenged the IRD assessments for the 2002 to 2005 income tax years.

16. NEWS ABOUT THE OFFICE 

We were delighted to receive news from Cynthia Gounder, an employee of Wood Walton, on the birth of Nikita on 15 May 2009.


Visit our new website. We have updated our website to a new user-friendly, information resource tool for clients. Have a look at www.woodwalton.co.nz. We welcome your feedback.