Hon Peter Dunne
Minister of Revenue
2007 Conference of the International Fiscal Association
Crowne Plaza, Christchurch
I'm very pleased to have been invited once again to open your annual conference.
A lot has happened since I addressed your conference last year.
Since then we have made major progress on the Business Tax Review, the review of our international tax rules and other major reforms on our tax policy work programme.
In what risks becoming a tradition, I'll quote Jo Doolan again this year, though we are not in continuous agreement, despite possible appearances. In a recent column she wrote:
"Overall, 2006 saw us starting a journey that is shaking up our stagnant tax system and waking up to the reality of the need for a competitive tax system if we want to play in global markets. A government working with business toward a platform on which economic transformation can become a reality."
And, yes, from my perspective, it is a journey of fundamental tax reform, one that is driven by the actual needs and experiences of the business sector, not just theory.
But while they are fundamental, they are also pragmatic and moderate reforms.
A good example of that pragmatism can be found in the recent passage of the offshore tax reforms.
Possible options ranged from full accrual taxation on unrealised capital gains, through to exempting offshore shares from any taxation other than on dividends.
What was introduced in the May 2006 bill was an attempted compromise between those two extremes, but it was widely held to be too complex.
Following extensive consultation with the private sector, a more pragmatic way of taxing offshore investment emerged in the form of the fair dividend rate method, a reasonable compromise which is now in legislation.
The government's tax reform programme is based on the confidence and supply agreement that was signed between Labour and United Future.
A key plank in that agreement was a major review of our business tax rules, with a view to ensuring that the system works to give better incentives for productivity gains and improved competitiveness with Australia.
Note that the focus is on being competitive with Australia.
Why Australia and why not China?
We would naturally like to have China's nearly 10 percent annual growth rate but we start from much higher income levels.
What we want is a high-wage economy, with a high-growth rate.
You can see an Australian focus in a number of our reforms that are under way, such as the international tax review, which takes as its starting point the Australian rules on taxing offshore income.
The same goes for our officials' review of the taxation of life insurance, which is looking at developing rules that have certain conceptual similarities to Australia's rules.
So why not just do as Australia does?
I agree that we can improve our way of doing things by doing some of what Australia does, but not everything.
Take Australia's capital gains tax, for example, a measure that I would not like to see introduced here.
So we are talking with New Zealand business to develop rules that are not only appropriate in the New Zealand context, but also meet our goal of being competitive with Australia.
The driving force behind the ideas set out in the Business Tax Review discussion document, released in July last year, is the strong desire to strengthen the ability of New Zealand businesses to grow and compete in an increasingly borderless international economy.
It represents the most comprehensive review of business tax arrangements since 1988, and arises as a direct consequence of the confidence and supply agreement between United Future and Labour, and when you consider the vast changes in the international environment and the advance of technology in that time, it was long overdue.
Our initial proposals were released for public consultation in July last year.
They included a reduction in the company tax rate to 30 cents; and improved assistance for research and development, as per United Future's policy.
And they also included proposals for new tax incentives to boost export market and skills development, matters of particular interest to the Labour Party, and a series of more technical changes to depreciation and asset write-offs, building on the substantial changes introduced in the 2005 Budget.
Altogether, they amounted to a programme which, if implemented in full, would cost just under $2 billion a year.
A corporate tax rate of 30 cents, without the accompanying capital gains tax, stamp duties, or compulsory superannuation levies, would certainly achieve the goal of retaining competitiveness with our major trading partner, Australia, in the first instance.
But that is not the only step we believe we should consider, which is where the targeted incentives for research and development, export markets and skills development come in.
The excesses of the 1970s and early 1980s have understandably given tax incentive schemes of this type a bad name, and one of the real challenges we confront is batting off the cynicism that we are about to repeat that awful nightmare all over again.
But equally one of the lessons of the later 1980s and the 1990s is that the preoccupation with things working in theory ahead of practice has been just as detrimental, so what has characterised our discussions on these issues has been the pragmatism I spoke of earlier.
We are looking for solutions that work, not fit a pre-determined ideological grid.
I expect detailed announcements to be made in the Budget, with legislation to follow shortly thereafter.
Complementary changes are being considered as part of our review of New Zealand's international tax rules.
I will be devoting much of my speech today to the international tax review since it occupies a large part of your conference programme.
The discussion document released late last year examines the principles underlying the current tax rules for offshore income and concludes that there is a good case for revising the current paradigm, which seeks to tax all offshore income as it is earned.
New Zealand is the only country that follows this approach to taxation, with the result that our rules are out of line with those of our major trading partners, in particular Australia.
And the costs of being different have grown.
The discussion document also looks at the case for reducing rates of withholding tax in New Zealand's double tax agreements.
Lower rates would encourage inward investment and benefit New Zealand firms investing offshore.
The discussion document examines a comprehensive reform of the current system - since simply tinkering would obviously not be enough.
The cornerstone of the new paradigm is an exemption from taxation for offshore active income, regardless of where it is earned.
Providing such an exemption would represent a fundamental departure from the principles underlying New Zealand's current tax system and therefore requires a rethinking of all of the provisions related to the taxation of income from foreign direct investments.
While the discussion document establishes a new approach to taxation, it deliberately does not put forward concrete proposals on how to implement it.
Rather, it canvasses the many provisions other countries have employed in implementing an active-passive distinction.
Taken as a whole, these provisions form a daunting list, one that has raised some concerns among commentators about the "worst case" scenario that would arise if all of them were to be implemented at once.
Let me assure you that that is not our intention.
Rather, as Dr Cullen and I said in the discussion document, we hope to draw on international experience in conjunction with our consultation process, to develop a set of proposals that are appropriate in the New Zealand context.
The development of the new rules depends crucially on input that we receive from New Zealand businesses.
Four principles will guide the development of the new system. They are as follows:
- First, the tax system should not discourage firms from undertaking expansion of business operations offshore to take advantage of market opportunities or gain production efficiencies.
- Second, the new rules should take into account the legitimate business arrangements and methods of operation that New Zealand businesses use in their offshore operations.
- Furthermore, the rules should maintain a level of protection for the domestic tax base.
- And finally, the rules should, as much as possible, reduce compliance burdens.
Obviously, it will be necessary to make trade-offs among these objectives.
The government is prepared to make them, to achieve a balance among the objectives, and we hope that business too will recognise the need for a reasonable balance to help us determine the appropriate mix of policies.
One obvious trade-off is between enabling businesses to expand offshore and protecting the source taxation of New Zealand domestic income.
We recognise the benefits of such expansion, although there obviously has to be a limit to the extent to which we can expose the domestic tax base to erosion.
Many provisions are used internationally in determining this limit.
- Some measures concentrate on the determination of the income to benefit from the exemption. These are the rules that define active and passive income and other rules such as base company rules.
- Many countries tax the dividends remitted by offshore subsidiaries, a backstop to the system which turns the active income exemption into a deferral.
- Finally, costs applied against the New Zealand tax base can be limited - for example, by extending the interest allocation rules.
- Overlying all of these provisions are the rules for transfer pricing.
And in New Zealand we have the further protection of the imputation system: in many cases there is an advantage to paying tax here rather than overseas.
To a certain extent, these approaches are alternatives; a tighter approach on one can allow a looser approach on others.
We are seeking businesses' views on which approaches are least disruptive to their operations.
The final trade-off is between the precision of the rules and the compliance burden they impose.
This is very important and will play a crucial role in determining which provisions should be implemented.
To develop rules that are consistent with how New Zealand firms operate their businesses, we asked our officials to conduct an extensive program of consultations directly with interested companies.
This program has been invaluable in providing detailed information with which to evaluate potential changes.
I would like to thank those company officers and members of the tax community who have given their time to this process on such short notice, many of whom are probably here today.
I assure you that we are listening and that your input will be influential in determining the rules which will be adopted.
I would like to share with you some of the lessons that have emerged in discussions with businesses, and reflect on some of the implications for the reform that have arisen from the discussions.
First and foremost, we have been impressed by the diversity and dynamism of New Zealand businesses operations overseas.
Businesses often use foreign operations to lever up domestic operations, allowing them to expand markets for domestically produced goods and increase production and organisational efficiency.
The discussions have confirmed the positive role that can be played by the internationalisation of New Zealand business.
The consultations have also confirmed the benefits both of moving to an active-passive distinction and of seeking to reduce our treaty withholding rates, particularly for non-portfolio dividends.
But there are challenges in finding a combination of provisions that fulfil the objectives discussed earlier, to the greatest extent possible.
Let me be clear that we do not believe that an active income exemption can be simply tacked onto the current system with no other changes to target the exemption to its intended policy.
Even so, discussions with companies also indicate that many of the provisions used internationally to target the exemptions are complex, may interfere with legitimate business arrangements and, in some cases, are ineffective in any event.
Let me give you some examples of the insights that have emerged from these discussions.
A number of countries, such as the United States and Australia, have introduced a broad concept of base company income, which is subject to accrual taxation, to protect against shifting domestic income offshore to obtain the exemption.
Consultation has demonstrated that these rules could potentially apply in situations that are part of the normal offshore business operations of New Zealand companies.
We will continue to work with companies to ensure that any base company rules are appropriately targeted and do not interfere with standard business practices.
Ideally, base company rules would not affect the vast majority of business arrangements and would apply as rarely as possible.
Again, this is dependent on reaching a reasonable balance in the overall package.
Many countries, such as the United States, Japan and the United Kingdom, tax repatriated dividends.
Such systems are complex and frequently ineffective.
Discussions with businesses revealed their preference for not taxing dividends.
As indicated in the discussion document, we are also attracted to exempting the dividend if rules to target the exemption in others areas are sufficiently robust.
An issue that has engendered considerable discussion has been the possible abolition of the so-called "grey list" of countries that have tax systems similar to ours.
Australia has retained a grey list in its application of the active-passive boundary.
There is no reason, in principle, to have a grey list once an active income exemption has been provided.
The issue is not gaining revenues from taxing the current level of passive income - most New Zealand companies have limited amounts of passive income, if any - rather, our concern is ensuring that the grey list cannot be used to reduce tax on what is, in substance, domestic income.
Businesses, on the other hand, have raised the legitimate concern that abolition of the grey list could entail an increased compliance burden.
For this reason, we are examining ways of providing a simplified threshold test, based on company books, which would exclude incidental amounts of passive income while offering adequate protection to the domestic income base.
Finally, the discussion document noted the conceptual case for extending interest allocation rules to companies making offshore investments. Australia has done that, but other countries with active income exemptions have not.
We will be considering very carefully the views of business in determining what changes should be made in this area.
Companies have also raised a number of technical issues addressed in the recent banking minimum capital rules.
Discussions have underlined that the issues for the general business environment are different from those for the banks and that a simple transfer of provisions from the bank rules to the general rules would not make sense.
I would like to reiterate my gratitude for the many useful comments received so far.
My officials will continue to work with business to develop a suitable framework for the new system.
In the meantime, the closing date for submissions on the ideas set out in the discussion document is 9 March, next week, a deadline that we extended in response to a number of requests for more time to prepare submissions.
I want to stress that this review is a matter of high priority for the government.
The first evidence of our strengthened international focus appeared in January, when it was announced that Australia and New Zealand have agreed to start the process for negotiating a revised tax treaty between the two countries.
That process includes consideration of withholding taxes.
Dr. Cullen and I intend to make announcements on the main framework of the new system by the middle of the year, and a further round of consultation on the technical implementation issues will follow.
If all goes well, they will be included in a tax bill expected to be introduced early next year.
As Minister of Revenue, one of my major interests lies in ensuring that our tax and tax-related social policy laws work well, so it is easy for people and firms to comply with the law and to meet their responsibilities.
For example, in October last year I released a discussion document proposing liberalisation of a range of tax penalties and associated legislation, to encourage voluntary compliance with the law.
The idea was to have tax penalties that reflect the seriousness of the offence, since people comply with the law more willingly when they see it as reasonable.
We have considered a wide range of submissions on that and other proposals, and if all goes well, they will all be included in the taxation bill planned for introduction in May.
The matter is awaiting Cabinet approval at present.
Most proposals will be unchanged from how they appeared in the discussion document.
One major change, however, concerns the proposal to refrain from imposing penalties when a taxpayer voluntarily discloses a shortfall.
There will be two changes to that proposal: we will remove the requirement that the disclosure be made within two years of someone taking a tax position, and the application date will be earlier, on the date of introduction of the bill.
Submissions were very supportive of the original proposal but recommended these two changes, which I agree will help to encourage voluntary compliance.
On a similar theme, legislation before Parliament makes improvements to the administration of the student loan scheme, particularly in relation to borrowers who are overseas.
Compliance is low amongst those borrowers, and the legislation may be creating disincentives for them to return.
Changes to simplify the administration of the loan scheme include allowing data matching between Inland Revenue and Customs, to ensure borrowers not based in New Zealand do not have access to interest-free loans.
At the same time, however, the bill introduces new, more realistic rules for borrowers going overseas that will make it easier for them to repay their loans, and offering them the chance of a "fresh start" to those who have fallen into arrears.
Further data matching between Inland Revenue and Customs will be a feature of child support legislation to be introduced in May.
The proposed changes will allow Inland Revenue to use cross-border departure and arrival information to help in the recovery of outstanding child support payments.
Child support is an area where it is especially challenging to reach a reasonable balance between the interests of those liable for support and those caring for children.
As Minister responsible for this area, I am committed to ensuring that liable parents meet their obligations but in a reasonable way.
There will be several other major policy events this year.
As you may know, the government is in the process of codifying the tax rules on general partnerships and introducing new rules on limited partnerships.
This is part of the wider aim to introduce modern limited partnership rules that seek to remove regulatory barriers to the flow of venture capital investment into New Zealand. A bill effecting these changes is expected to be introduced by the middle of this year.
The Income Tax Bill, which is currently before Parliament, is expected to pass in August, all going well.
The bill represents the final stage of the 15-year rewrite of the Income Tax Act, and its completion is an impressive achievement.
The purpose of rewriting the Act, as you may know, is to reduce compliance costs by producing tax legislation that is clear, uses plain language and is structurally consistent.
I must pay a special tribute here to the contribution of Sir Ivor Richardson to this mammoth task, because without his dedication, and commitment, I doubt the process could have been completed.
Also this year, there will be major announcements relating to charities and charitable giving, the result of another key feature of the Labour-United Future confidence and supply agreement.
The government last year released a discussion document canvassing views on possible tax incentives to encourage charitable giving of money, skills and time.
We have analysed the many submissions received on the ideas put forward in the discussion document, and I expect that we will soon be able to announce changes that recognise the invaluable contribution to New Zealand society made by the charitable, community and voluntary sectors.
This year also sees the start-up, in July, of KiwiSaver, which is a key part of the government's strategy to increase personal savings, and therefore the country's economic performance.
KiwiSaver was an important influence on the recently enacted investment tax reforms, which were necessary to remove the significant tax disadvantages for individuals saving through managed funds.
Before I close I would like to pay tribute to David Butler, Commissioner of Inland Revenue, who leaves this month for a position in the OECD.
I was chairman of the Finance and Expenditure Committee in the late 1990s during its inquiry into the powers and operations of Inland Revenue.
The inquiry was conducted in an atmosphere of growing concern about the way the department operated, and that it was sometimes too heavy-handed and inflexible in its dealings with taxpayers.
Since David Butler's appointment in 2001, I have noticed many positive changes in the public's perception of Inland Revenue, which is a major achievement for him as Commissioner.
I'll conclude by saying that last year was an extremely demanding year in tax policy.
It was demanding of government and the private sector alike, and meant a lot of work for you all in participating in tax policy development.
This year is expected to be at least as heavy as a result of tax initiatives resulting from the Business Tax Review and the international tax review, as well as all the other reforms that are under way.
Thank you and best wishes for your conference.
Dunne: Tax reforms pragmatic and fundamental
Pragmatism and a genuine desire to listen are at the heart of the government's current tax reform programme, Revenue Minister Peter Dunne told the International Fiscal Association conference in Christchurch today.
He told the conference the tax reforms were fundamental and intended to assist the long-term goal of economic transformation.
Mr Dunne announced a bill planned for introduction in May will reduce the number of penalties faced by people who have a tax shortfall if they tell Inland Revenue about it before they learn they are to be audited.
He said the change, once enacted, would apply from the date of introduction of the bill.
The bill was expected to include a number of changes relating to tax penalties and associated legislation, designed to encourage voluntary compliance with the law.
"The idea was to have tax penalties that reflect the seriousness of the offence, since people comply with the law more willingly when they see it as reasonable," Mr Dunne said.
The proposed changes were outlined in a discussion document released last year for public consultation, he said, and most proposals would remain unchanged from how they were set out there.
"One major change, however, concerns the proposal to refrain from imposing penalties when a taxpayer voluntarily discloses a shortfall," he said.
"There will be two changes to that proposal: we will remove the requirement that the disclosure be made within two years of someone taking a tax position, and the application date will be earlier, on the date of introduction of the bill," Mr Dunne said.
Mr Dunne said, "We are talking with New Zealand business to develop rules that are not only appropriate in the New Zealand context, but also meet our goal of being competitive with Australia.
"The driving force behind the ideas set out in the Business Tax Review discussion document, released in July last year, is the strong desire to strengthen the ability of New Zealand businesses to grow and compete in an increasingly borderless international economy.
"It represents the most comprehensive review of business tax arrangements since 1988, and arises as a direct consequence of the confidence and supply agreement between United Future and Labour, and when you consider the vast changes in the international environment and the advance of technology in that time, it was long overdue.
"Our initial proposals were released for public consultation in July last year.
"They included a reduction in the company tax rate to 30 cents; and improved assistance for research and development, as per United Future's policy.
"And they also included proposals for new tax incentives to boost export market and skills development, matters of particular interest to the Labour Party, and a series of more technical changes to depreciation and asset write-offs, building on the substantial changes introduced in the 2005 Budget.
"Altogether, they amounted to a programme which, if implemented in full, would cost just under $2 billion a year.
"A corporate tax rate of 30 cents, without the accompanying capital gains tax, stamp duties, or compulsory superannuation levies, would certainly achieve the goal of retaining competitiveness with our major trading partner, Australia".
The Revenue Minister's full speech is available at www.taxpolicy.ird.govt.nz
Cell: 021 638 920