KPMG client seminar 31 May 2006 (Auckland) and 1 June (Wellington)
Thank you for the invitation to speak to your seminar today.
You have asked me to update you on tax policy matters and to comment on future developments.
The MMP environment
I will begin by making a few observations on aspects of the political and parliamentary environment that influence tax policy and legislation under MMP.
Gone are the days of majority governments so strong that tax policy proposals could be expected to move quickly and relatively unchanged through to legislation.
There were times when that did not happen, of course, but they were not common.
Dead of night tax legislation is now but a memory of the distant past.
Policy development and law-making are more complicated now than they were before MMP, and they take more time.
At present we have a Labour-led minority government that has entered into confidence and supply agreements with two other parties, one of them United Future, in order to be able to govern.
That adds complexity to the policy development process, and slows it down, because of the number of views, perspectives and priorities that must now be taken into account and managed.
And we have a Minister of Revenue from outside not only the major party of government, but also the government itself.
As Minister of Revenue, I am solely responsible for all revenue areas except tax policy.
Responsibility for tax policy rests jointly with the Minister of Finance, Dr Cullen, and me.
We exercise that through a regular weekly meeting where all policy issues are discussed and policy decisions made.
Select committee work
Also, under MMP, bills cannot be rushed through select committees, since their composition generally reflects the proportionality of Parliament.
The powerful Finance and Expenditure Committee, which scrutinises taxation bills on behalf of Parliament, is made up of four Labour MPs, four National MPs, and one each from United Future, Act, the Green Party, Maori Party and New Zealand First.
There is no majority, and no party has control of the committee, so proposed legislation must be carefully managed through the select committee process.
It takes time, patience and a certain degree of compromise to arrive at majority agreements.
As Minister, I cannot be certain when bill a is referred to a select committee what shape it will be in when it emerges, which means that the power of submissions to the select committee to influence the outcome is much greater than ever before.
The acclaimed generic tax policy process, which was established in 1994, constitutes an excellent framework for working under MMP.
It, too, slows down policy-making by requiring consultation with affected taxpayers at key points in the process, well before proposed changes appear in a bill.
I think all agree that the delay is worth it, however.
Early consultation results in better policy proposals and, ultimately, better legislation.
Potential problems with proposed changes tend to be exposed early in the policy process, and many have been worked through before the changes appear in a bill to be considered by a select committee.
I am aware that taking part in the generic tax policy process takes up a lot of private sector time and resources, and I am greatly appreciative of those efforts.
I know that a lot of work goes into your lengthy submissions on various government discussion documents and issues papers, as well as consultation directly with officials.
The alternative, however, is not to seek your views on proposed policy, or to seek them to a lesser degree – and I do not think that would be acceptable to most tax professionals these days.
Business tax review
The post-election confidence and supply agreement signed between United Future and Labour resulted in the addition of three important items to the government's tax policy programme.
Chief of these was the major business tax review that is under way now.
Its purpose is to ensure the tax system works to give better incentives for productivity gains and improved competitiveness with Australia.
We are making good progress and are well on track to issue in July a discussion document outlining a number of possible initiatives.
When pushing in our post-election negotiations for some commitments on tax from the government, United Future laid particular emphasis on business tax reform because of what we regarded as the more pressing need, especially since the advent of the Working for Families package had enhanced the situation of nearly 350,000 New Zealand families.
However, it is also true that business tax rates cannot be considered in isolation from their impact on personal tax rates, and that any significant cut in business tax rates will raise questions about personal tax rates.
But they are questions that will be answered on another day, not today.
The two other tax elements of United Future's agreement with the government include a review of the charitable donations rebate regime which will be getting underway later this year, and the preparation of a government discussion paper on income splitting, due for publication early the following year.
This latter document assumes greater significance given the increasing debate about ways in which household income can be boosted, and also the increasing use of income splitting today as a tax avoidance mechanism to offset the incidence of high marginal tax rates, something the IRD highlighted in its Briefing to me as the Incoming Minister.
The work programme
The tax policy work programme that we released in March is an interim one that carried over projects from the previous work programme, or that had been previously announced, but does not extend much beyond the middle of the year.
The definitive work programme to June 2007 will be announced once the resource and policy implications of the business tax review are clearer.
In the meantime, work on a number of other policy projects continues at a vigorous pace.
The first tax bill of the year was introduced in mid-May, passed its first reading last week and was referred to the Finance and Expenditure Committee for consideration and hearing of submissions.
The main feature of the bill is a wide-ranging reform of the taxation of income from share investments, whether through managed funds or direct investment by individuals.
You will all have heard of the proposed changes, if nothing else from the full-page newspaper advertisements paid for by an interested party.
The proposed changes on investment income were the subject of extensive consultation for over two years before being included, in modified form, in the recent tax bill.
The select committee submission process will allow a further opportunity for the public to air its views.
The current rules operate very unevenly and are riddled with inconsistencies.
They favour direct investment over investment through funds, and they favour higher income investors through funds over lower income investors.
They favour investment overseas over investment in New Zealand, and they favour overseas investments in some countries over investment in others.
The reform places the tax rules on different types of share investment on an equal footing, introducing greater fairness and reducing distortions in investment decisions.
Levelling the field means that some will lose their disadvantages and some will lose their tax-favoured treatment.
On the whole, more people will be better off under the changes.
One half of the reform package is removing the disadvantages facing people who invest through managed funds, which many people do.
More people, especially lower income and middle income people, are expected to invest through funds after the work-based KiwiSaver scheme is in place.
The most notorious of the disadvantages of investing through funds is, of course, the flat 33% tax rate on share gains, which overtaxes those on a lower income tax rate.
Under the proposed changes, lower income investors through funds will be taxed at their correct rate.
Most commentators appear to support that part of the equation.
It is the other half of the reform that is arousing controversy – the half relating to overseas investment, especially direct investment in offshore shares.
I do not have time today to go into the detail of the proposed offshore changes but, briefly, they do three things:
- They remove the tax advantages enjoyed by individuals who invest directly in shares in the eight "grey list" countries.
- They reduce the tax disadvantages of investors into countries that are not on the grey list, the non-traditional investment destinations.
- And they ensure that direct investment is not tax-favoured over investment through funds.
Much of the concern about these proposals appears to be coming from small investors in offshore shares, many of whom are unlikely to be adversely affected by the changes to the offshore rules.
People with significant investments into grey list countries, however, will be expected to pay a reasonable level of tax on their investment income.
Select committee scrutiny of the bill will be invaluable to fine-tuning the proposed changes and will undoubtedly throw light on any unintended effects.
Given what I said a little earlier about the enhanced role of select committees in the current political environment, I am looking forward to the select committee process on this bill.
I am encouraging all those with a view on the bill, whether it be that they do not like what has been proposed, or that they think we have got it wrong, or have not gone far enough in some cases to come along and have their say.
But let me make this point.
Telling the select committee that one is for or against a particular measure is of limited value.
I for one am much more interested in hearing specific, practical proposals on how the legislation can be improved, and I would urge all those making submissions to focus on that aspect, rather than just whether they like the bill or not.
What's coming up
To turn to other forthcoming events, a discussion document outlining proposed changes to the tax treatment of general and limited partnerships should be ready for release in a few weeks' time.
The main impetus for the tax changes is the forthcoming introduction of updated rules on limited partnerships, which are separate legal entities, to facilitate venture capital investment.
That will require the parallel updating of the tax rules on general and limited partnerships.
Another discussion document to be released later in the year will deal with a range of concerns about tax shortfall penalties.
In particular, it will look at the interaction between the penalty for taking an unacceptable tax position and the penalty for lack of reasonable care.
The discussion document will also look at ways of more closely aligning penalties with Inland Revenue's graduated "compliance model", which tailors departmental responses to taxpayer behaviour.
It takes into account gradations of offending, which means being helpful to taxpayers who try to comply with the rules but don't always succeed, but using the full force of the law on those who have decided not to comply.
In July or August I expect to see a flurry of Orders in Council that will complete the legislative procedures in New Zealand relating to two new double tax agreements and amending two existing ones.
The new DTA with Spain is waiting in the wings.
Spain has completed its legislative requirements, so when New Zealand's are complete and diplomatic exchanges have taken place, the new DTA will come into effect.
The new DTA with Poland is making progress.
We will soon have completed our domestic procedures but Poland has a way to go yet, I am told.
Amending protocols to our DTAs with Australia and Singapore will also have completed the legislative process in New Zealand but must await corresponding developments in the two countries.
The rewrite of the Income Tax Act is drawing to a close this year, and the final exposure drafts of rewritten legislation are being released this week for consultation.
The next step will be the development of the rewrite bill for introduction into Parliament.
The rewrite of our income tax legislation began back in the 1990s, at about the time the United Kingdom and Australia began to rewrite their own Acts.
Its completion will be an historic achievement for the people who have worked on it over all those years.
To conclude, it is obviously an extremely busy time on the tax policy front.
The major event of the year is, of course, the business tax review, with the publication of a resulting discussion document planned for mid-July.
I look forward to hearing your views on the proposals.
I wish you a very successful seminar. Thank you.