Budget-related measures added to GST Bill
7 December 2010
A supplementary order paper released today proposes the addition of measures to the Taxation (GST and Remedial Matters) Bill. The measures include improving the integrity of social assistance programmes, reforming the qualifying companies rules and clarifying the depreciation rules for buildings. The changes included in the SOP were foreshadowed in Budget 2010. For more information see the media statement and fact sheets, Supplementary Order Paper No. 187 and the regulatory impact statements.
Hon Peter Dunne
Minister of Revenue
Tax changes will increase fairness
Proposed new tax rules, released today, will increase the integrity of the tax system and help ensure everyone pays their fair share, Finance Minister Bill English and Revenue Minister Peter Dunne say.
Mr Dunne today released a Supplementary Order Paper (SOP) that will introduce several Budget 2010 tax measures to the Taxation (GST and Remedial Matters) Bill, which is nearing its final stages in Parliament. MPs are expected to debate the amendments on Thursday.
The proposed changes, which have been finalised after public consultation over the past few months, will:
- Broaden the definition of income for Working for Families, Student Allowance and the Community Services Card to help prevent people structuring their income to inflate their entitlements.
- Close loopholes in the tax treatment of loss attributing qualifying companies (LAQCs) so shareholders can no longer claim losses against their personal income.
- Ensure people can still claim accelerated depreciation on the fit-out of commercial and industrial buildings. They will also be able to claim the depreciation loading on assets where investment decisions were made before 20 May 2010, but not completed until sometime after.
Mr English says the changes increase fairness and consistency.
"These changes will reduce the opportunities for well-off people to structure their affairs for tax purposes," Mr English says.
"Sheltering income to inflate Working for Families or Student Allowance payments is unfair to people in genuine need and to the taxpaying public which foots the bill for these assistance programmes. This change is expected to reduce spending on Working for Families tax credits by $32 million a year.
Mr Dunne says the changes will apply to Working for Families and the Community Services Card from 1 April, 2011. The Student Allowance changes will apply once an Order in Council is made.
"The broader definition of income for social assistance will include income from family trusts, some fringe benefits in certain circumstances, income from a cash PIE that is not locked in and income from a spouse living overseas," Mr Dunne says.
"Changes to the treatment of QCs and LAQCs will ensure that owners cannot claim a tax deduction on losses at a higher rate than they pay on profits.
"Since Budget night there has been considerable consultation on the implementation details of the tax measures announced and I believe the changes outlined today are a fair and pragmatic response," Mr Dunne says.
Other changes in the SOP lower the tax rates for Maori Authorities and the personal income tax rates for non-resident seasonal workers in line with the lower personal tax rates announced in the Budget.
Fact sheets on the SOP changes are available at: www.taxpolicy.ird.govt.nz
The changes are part of the second stage of the Government's Budget 2010 tax package and follow the 1 October tax cuts and GST increase. Once the Taxation (GST and Remedial Matters) Bill is passed the tax measures that will take effect from 1 April 2011 (or the 2011/12 income year) include:
- A cut in the company tax rate from 30 per cent to 28 per cent.
- A cut in the tax rate faced by unit trusts, life insurance policyholders and some other savings vehicles from 30 per cent to 28 per cent.
- Ending landlords' and businesses' ability to claim depreciation on buildings with an estimated useful life of 50 years or more.
- Tightening the rules for LAQCs and QCs so shareholders cannot deduct losses at their marginal tax rate and pay tax on profits at the lower company rate.
- Changes to the thin capitalisation tax rules to limit the scope for foreign multinationals to reduce their New Zealand tax liability.
- Tightening the definition of income for Working for Families, Student Allowance and the Community Services Card.
- Ending the automatic CPI indexation of the Working for Families abatement threshold to stop higher-income recipients getting bigger increases than those on lower incomes.
- An increase in IRD audit and compliance activity to improve the integrity of the tax system.
Media contacts: Grant Fleming 021 277 9869 (Minister English)
Mark Stewart 021 243 6985 (Minister Dunne)
- Improving the integrity of social assistance programmes (PDF 68KB)
- Changes to the qualifying company rules (PDF 26KB)
- Post-budget changes to tax depreciation rules (PDF 22KB)
- Change to the Māori Authority tax rate (PDF 92KB)
- Tax rate change for non-resident seasonal workers (PDF 19KB)
Improving integrity of Working for Families and other social assistance programmes
The changes described below follow the Government’s announcement in Budget 2010 to improve the integrity of certain social assistance programmes, namely Working for Families (WFF), Student Allowances and the Community Services Card.
The changes are intended to counter people structuring their affairs to inflate their entitlements. This will prevent people exploiting gaps in the current definition of family income.
The changes will ensure the rules achieve their original intention of targeting assistance to people in genuine need rather than providing it to people with sufficient means.
As a first step to addressing integrity concerns around social assistance programmes, the Government excluded investment losses such as rental losses for the purpose of determining WFF tax credits. This was included in the Taxation (Budget Measures) Act 2010.
The move to recognise different sources of income and exclude investment losses for WFF will reduce tax credit spending by $32 million a year from
Further changes will apply to WFF tax credits and the Community Services Card from 1 April 2011. The changes to the Student Allowances parental income definition will be made separately by Order in Council.
The changes outlined below refer to the definition of income for WFF tax credits. The Community Services Card and the parental income test for student allowances use the same definition of income. Therefore, any changes to this definition of income will also apply to these two other types of social assistance.
Family income for WFF already includes beneficiary income of a trust but does not include distributions of trustee income. Large amounts of trustee income can be distributed to a family to live on without affecting their WFF entitlements. Changes are being made to the way trustee income is treated to reflect the actual level of income a family has available to them. This includes the income from trust-owned companies.
- A trust-owned company will be defined as a company in which the trustees and their associates hold 50% or more of the voting interests (or market value interests).
- Trustee income will be attributed to a settlor of the trust. Trustee income will be the net income of a trust (less income distributed as beneficiary income) and the net income of trust-owned companies (less dividends from such companies).
- To avoid over-reach of this rule, the settlor for WFF purposes will exclude anyone who provides personal services for free for a trust’s administration or the maintenance of the trust’s property.
- If there is more than one settlor for a trust, the trustee income will be attributed to the settlors of the trust proportionally. However, if a settlor arranges for friends or relatives to be settlors to artificially dilute the attribution rule, the original settlor will be treated as the sole settlor of the trust. This is a result of the existing settlor definition (including nominee look-through rule) and anti-avoidance rule.
- Some trusts such as charitable trusts will be specifically excluded. Income from these trusts will not be attributed to the settlor for WFF purposes.
- Currently, fringe benefits are not included as income when determining WFF entitlements. In some circumstances, people can arrange a proportion of their remuneration to be paid as fringe benefits instead of wages, lowering income for WFF purposes. This may happen when the employee exercises control over the make-up of their remuneration.
- Significant fringe benefits that are easily substitutable for cash, such as motor vehicles or low-interest employee loans, will be counted as family income.
- This rule will apply only to shareholder-employees. A person will be a shareholder-employee of a company if they, together with associates, hold 50% or more of the shares in the company.
Passive income of children
Large amounts of income can be allocated to children via family trusts and companies or by investments being placed directly under their names, artificially lowering parents’ income for WFF purposes.
- Under the new rules, any passive income over $500 per child per year will be counted as family income.
- Passive income for WFF purposes will include interest, dividends, royalties, rents, and a taxable Māori Authority distribution other than a retirement scheme contribution.
- Passive income will also include beneficiary income from a trust but will exclude certain types of income received such as income from certain testamentary trusts (consistent with the minor beneficiary rule).
- Wages of children will not be counted as family income.
Unlocked portfolio investment entities
- Income from unlocked portfolio investment entities (PIEs), that are easily accessible (such as cash PIEs), will be counted as family income because such income is akin to interest earned on bank accounts which are currently counted.
- Unlocked PIEs will be defined as all PIEs other than superannuation schemes that are registered with the Government Actuary, such as KiwiSaver schemes or retirement savings schemes. These schemes are excluded on the basis that the income is sufficiently locked-in until a person’s retirement.
Income of non-resident spouse
- A person might live in New Zealand with their child while their spouse lives and works overseas. Because the non-resident spouse’s world-wide income is available to meet the family’s living expenses it will be counted as family income.
Tax-exempt salary and wages
- Tax-exempt salary and wages of people under specific international agreements will be counted as family income. Such salary and wages are available to meet the family’s living expenses.
- An example would be salaries received by employees of international organisations such as the United Nations or the Organisation for Economic Co-operation and Development.
Main income equalisation scheme deposits
The main income equalisation scheme is intended to allow persons carrying on an agricultural, fishing or forestry business to smooth their income for tax purposes to address large fluctuations of income over several years. A deposit to a main income equalisation account, which is allowed as a deduction, lowers their taxable income and currently also lowers income for WFF purposes.
- Deposits entered in a person’s main income equalisation account will now be counted as family income. To prevent double counting, refunds (excluding interest) from these accounts will not be counted.
Private pensions and annuities
- 50% of non-taxable private pensions and annuities will be included in family income.
- A family may be receiving payments other than those already included in the definition of family income and that are used to meet the family’s living expenses. These will also be counted, unless otherwise stated, if the total exceeds $5,000 a year. Examples of such other payments include distributions of trustee income from family trusts where the person is not the settlor of the trust and regular cash payments from family members.
The Government announced in Budget 2010 that the qualifying company rules would be amended. A new transparent form of tax treatment would be introduced to ensure that shareholders who use a company’s losses also pay tax on any company profit at their marginal tax rate.
The changes introduced today:
- change the tax treatment of loss attributing qualifying companies (LAQCs) so shareholders can no longer claim losses against their personal income. This will prevent these shareholders being able to claim losses at their higher marginal tax rate and profits at the company tax rate;
- allow existing qualifying companies (QCs) and LAQCs to continue to use the current rules without the ability to attribute losses, pending a review of the dividend rules for closely held companies;
- provide look-through income tax treatment for electing closely-held companies.
- allow QCs and LAQCs to transition into a new look-through company (LTC) vehicle or change to another business vehicle such as a partnership, without a tax cost during the period 1 April 2011 to 31 March 2013.
What does “look-through” mean?
- “Look-through” effectively means that we ignore the company, which is the legal entity carrying on a business, and tax its shareholders on the company’s profits instead. It also means that shareholders can use a company’s losses against their other income, subject to the loss limitation rule.
- Look-through treatment applies for income tax purposes only. An LTC retains its corporate obligations and benefits, such as limited liability, under general company law.
- An LTC’s income, expenses, tax credits, rebates, gains and losses are passed on to its owners. These items are allocated to each person in proportion to the number of shares they have in the LTC.
- The income of an LTC is taxed and expenses are deducted as if each owner had received that income and incurred the expenses personally. Any profit is taxed at the owner’s marginal tax rate. The owner can use any losses against their other income, subject to the loss limitation rule.
- The LTC loss limitation rule is similar to that for limited partnerships. This means owners can offset tax losses only to the extent the losses reflect their economic loss. Any loss that cannot be used is carried forward and may be claimed in future years, subject to the application of the loss limitation rule in those years. There are certain rules about the use of these losses if the LTC ceases to be an LTC, or if the owner sells their shares.
- An LTC is still recognised separately from its shareholders for certain other tax purposes, including GST, PAYE, and certain administrative or other withholding tax purposes under the Income Tax Act.
What sort of company can use the LTC rules?
- The rules are designed for closely held companies which are resident in New Zealand.
- An LTC must have five or fewer “look-through counted owners”. Related shareholders may be treated as a single owner for the purposes of this test – for example, if a mother and daughter both hold shares in an LTC they are treated as “one” owner. There are special rules for determining who counts as an owner when shares are held by trustees.
- Only a natural person, trustee or another LTC may hold shares in an LTC. All the company’s shares must be of the same class and provide the same rights and obligations to each shareholder.
How does a company become an LTC?
- All owners must elect for a closely held company to become an LTC. Once a company becomes an LTC it will remain in the LTC rules unless one of the owners decides to opt out, or if it ceases to be eligible – for example, by having more than five counted owners.
- LTC election forms will be available early next year from Inland Revenue. In the interim companies can elect just by writing to Inland Revenue with details and signatures from all their shareholders, and details of the shareholding of each.
- Elections should be received before the start of the income year to which they apply. However for the next two income years (starting from 1 April 2011), existing QCs and LAQCs have a six-month extension period to decide whether to transition to the LTC rules (see “Existing QCs and LAQCs” below).
What happens when an owner sells their shares in the LTC?
- Owners of an LTC are treated as holding LTC property directly, in proportion to their shareholding. When owners sell their shares they are treated as disposing of their share of the underlying LTC property. If this includes, for example, revenue account property or recovery of depreciation, the shareholder may have to pay any tax associated with the disposal. Tax will only be due if the disposal amounts are above certain thresholds.
- If the company stops using the LTC rules or if the company ceases to exist there will be a deemed disposal and acquisition of the company’s property at market value. This may mean the shareholders have to pay tax on any income arising from the deemed disposal.
Existing QCs and LAQCs
Existing QCs and LAQCs have several options to choose from in one of the first two income years starting on or after 1 April 2011; the year they choose is called the “transitional year”. These rules apply only to companies that are already QCs or LAQCs in the 2010–11 income year.
They can continue to use the QC rules. Or if they choose to leave the QC rules, they can have a smooth transition into the LTC rules or they can choose to change their business structure into a partnership, limited partnership or a sole trade, with no tax cost.
The QC or LAQC can:
- Continue as a QC, without the ability to attribute losses. The QC rules are otherwise unchanged.
- This will be the “default” option for all existing QCs and LAQCs.
- An LAQC will no longer be able to attribute losses to shareholders.
- Income will be taxed at the company level, and only dividends with imputation credits attached will be taxable to shareholders.
- Capital gains can be distributed tax-free without winding up the company.
- Choose to be taxed as an ordinary company.
- The QC or LAQC election must be revoked.
- Any losses must be used by the company, not the shareholders.
- All dividends will be taxable to shareholders, although imputation credits may be attached.
- Choose to be taxed as a look-through company (LTC).
- Existing QCs and LAQCs have six months from the start of their transitional year to elect to become an LTC.
- Look-through treatment will apply from the start of the transitional year.
- Transition to become a limited partnership, an ordinary partnership, or sole trade.
- Owners of existing QCs and LAQCs have up to six months from the start of their transitional year to tell Inland Revenue that they will restructure their business into a limited partnership, an ordinary partnership, or become a sole trader.
- The partnership or sole trade must consist of the same person(s) who owned the QC or LAQC.
- The transition into the new business form must be completed by the end of the transitional year.
Budget 2010 removed depreciation deductions for most buildings from the start of the 2011–12 income year. At the same time the Government announced a review of the tax treatment of commercial building fit-outs to ensure that depreciation allowances apply to commercial and industrial building fit-outs.
- Following this review, the bill introduces new rules to ensure that the fit-out of commercial and industrial buildings will continue to be depreciable.
- Budget 2010 also removed depreciation loading for assets purchased after 20 May 2010. The bill makes technical changes to these rules to ensure that depreciation loading still applies to assets where investment decisions were made before 20 May 2010 but not completed until sometime after.
Commercial fit-outs depreciable
- The law will be clarified so that commercial and industrial fit-out remains depreciable property.
- The law relating to residential fit-outs will remain unchanged. Residential fit-out is generally non-depreciable as set out in the Commissioner of Inland Revenue’s Interpretation Statement IS10/01.
- Items of fit-out that are shared between commercial and residential purposes – for example, lifts, electrical cabling, fire protection, sewerage and water reticulation in a mixed-purpose building will be depreciable if the dominant purpose of the building is commercial. Fit-out used only for commercial purposes will be depreciable property.
- The new rules recognise that there are commercial buildings that provide residential-type accommodation by excluding a number of these types of buildings from the meaning of “dwelling”. This will ensure that fit-outs associated with these buildings will continue to be depreciable. The types of buildings that will be specifically excluded from the meaning of “dwelling” are:
- hotels, motels, inns, hostels, or boarding houses;
- certain serviced apartments;
- convalescent homes, nursing homes, or hospices;
- rest homes or retirement villages, from hospital care through to residential care facilities; and
- camping grounds.
- A new rule will allow commercial building owners, who did not itemise building fit-out separately from the building at the time of acquisition, to amortise up to 15% of the building’s adjusted tax book value at 2% straight-line per year until the building is disposed of.
Depreciation loading was removed on a prospective basis as part of Budget 2010. Loading continues to apply in respect of assets purchased or constructed before 20 May 2010 or when there was a commitment to purchase or construct an asset on or before 20 May 2010. While the existing legislation that gave effect to this grandparenting worked in most situations, its result was unclear in others.
- Under the new rules an asset will be eligible for depreciation loading if:
- it is acquired on or before 20 May 2010; or
- there was a decision to purchase or construct it and its owner either:
- entered into a binding contract for its purchase or construction on or before 20 May 2010; or
- incurred expenditure in relation to it on or before 20 May 2010.
- The first part of this rule will cover assets that were clearly purchased on or before 20 May 2010. The second part will cover situations when there was a clear commitment to purchase an asset, but when the purchasing process was incomplete or, for an asset under construction, when the asset was not yet built.
- Evidence of a decision to purchase or construct an asset can be provided through documents that conclusively show such a decision had been made. Alternatively, a decision can be evidenced through a statutory declaration sent to the Commissioner of Inland Revenue that states that a decision had been made.
Tax rate change
Māori Authorities are taxed as a proxy for their members. They are currently taxed at 19.5%, which was the statutory tax rate for the majority of Māori Authority members when the current rules were introduced. As a result of changes to personal marginal tax rates in Budget 2010, the Māori Authority tax rate will drop to 17.5% to align it with the individual marginal rate of the majority of Māori Authority members. The change will apply from the 2011–12 income year, the same effective date as the company tax rate decrease.
Consequential amendments are being introduced to accompany the rate change. These are similar to those introduced for companies as a result of the lowering of the company tax rate in Budget 2010. They are:
- “Grandparenting” imputation ratios – When the Māori Authority tax rate is lowered, this will automatically adjust the ratio at which a Māori Authority can attach Māori Authority tax credits to distributions. The result is that pre-rate change credits can be “trapped” in the Māori Authority, leading to effective double taxation when the relevant income is distributed. A “grandparenting” period of two years is being introduced to allow Māori Authorities an opportunity to review their credit accounts and make distributions of pre-rate change profits at the existing credit ratio if they wish.
- Provisional tax adjustments – An adjustment is being made to the provisional tax rules so that the new rate is immediately reflected in the tax paid by Māori Authority provisional taxpayers. This recognises the fact that, all other things being equal, the tax paid is expected to be less in the year of the decrease. For Māori Authorities that base their provisional tax on an earlier year’s tax obligations, this will be achieved by amending the uplift factor used to calculate their current year liability. Provisional taxpayers that actually estimate their liability will be unaffected by these changes, as they would factor the lower rate into their estimates.
Improving accuracy of non-resident seasonal workers tax rate
- The personal tax rate that applies to non-resident seasonal workers is being changed to 10.5% and will apply from 1 April 2011. The new rate better reflects the income levels earned by these workers while working in New Zealand, particularly since personal tax rates were lowered in Budget 2010. The previous rate was 15%.
- The non-resident seasonal worker tax rate is used by workers employed from Pacific Island nations under the Recognised Seasonal Employer scheme. The scheme is administered by the Department of Labour.
- The non-resident seasonal worker rate is a flat rate of tax which reflects the average tax rate faced by these workers on their New Zealand-sourced income according to the personal tax rate scale.
- Recent data shows that 80% of non-resident seasonal workers have New Zealand income of less than $14,000. This indicates that the rate should now be set at the lowest marginal rate of 10.5%.
- The tax rate change will take effect from 1 April 2011