Speech to Deloitte's client seminar
Update on tax policy
I am very pleased to be here today to address your client seminar.
As you will know, with Budget 2007 still a relatively fresh memory for most of us, a lot has been happening in tax policy – and that is expected to continue over the next year or so.
Much of the Budget was devoted to tax-related changes, many of them the most substantial business tax changes to be announced since the late 1980s.
I want to take this opportunity to update you on policy developments, covering as well a number of areas that may have been somewhat overshadowed by other Budget announcements.
The big items in the Budget, from a tax and business perspective, were the announcements of:
- additional incentives to save with KiwiSaver,
- the business tax reform package,
- tax incentives to encourage charitable giving,
- and the proposed introduction of an active income exemption for New Zealand-controlled foreign companies.
Two taxation bills tabled in the course of the Budget debate introduced many of these measures, as well as other tax reforms.
One of the bills gave effect to urgent Budget announcements such as the reduced company tax rate, the associated reduction in the tax rate for certain savings vehicles, and the new member tax credit for people who contribute to KiwiSaver schemes. That bill was passed under urgency.
The other bill received its first reading and was referred to the Finance and Expenditure Committee for consideration. I will return to that bill and some of its other contents later.
First, however, I want first to touch upon the Budget announcements.
Transformation of New Zealand's savings culture was a major theme of the Budget.
The past few years have seen important reforms aimed both at making it easier for people to save and at improving the tax treatment of savings through collective investment vehicles. Legislation enacted last year paved the way for the introduction of KiwiSaver in July this year.
Further legislation last year brought in new tax rules on investment income, including the new portfolio investment entity – or PIE – rules, which come into effect in October.
A key role of the new PIE rules is to prevent the over-taxation of lower income people who invest through managed funds, which are the first investment choice of many ordinary New Zealanders. And they and similar funds are the vehicles through which KiwiSaver will operate.
This continuing tax reform of the savings environment took a giant step forward with the Budget announcements of the introduction of additional incentives to save with KiwiSaver.
These new incentives include:
- a member tax credit of up to $20 a week,
- compulsory matching contributions by employers of up to 4 per cent of employees' gross salary or wages – to be phased in over four years,
- and a tax credit for employers of up to $20 a week per employee to reimburse them for their contributions.
These changes are designed to boost incentives for people to join the savings scheme and to continue to make contributions throughout their working lives, ensuring that all New Zealanders have a decent standard of living in retirement.
Another, very important group of Budget announcements related to business tax reforms have resulted from the Business Tax Review. The review itself was a direct result of policies stipulated in the Confidence and Supply Agreement between United Future and Labour and between New Zealand First and Labour.
Our requirement was for, and I quote:
"…..a review of the current business taxation regimes, with the view of ensuring the system works to give better incentives for productivity gains and improved competitiveness with Australia."
The resulting Business Tax Review set out to do just that. The first step was the release last year of a discussion document that canvassed views on possible tax initiatives aimed at increasing productivity and making us more competitive internationally.
Amongst the options canvassed were reducing the company tax rate from 33% to 30% and introducing targeted tax credits.
The discussion document was followed by further extensive consultation and policy development that resulted in the business tax reform package announced in the Budget.
Top of the list of business tax reform measures was the reduction of the company tax rate, from 33% to 30%, from the 2008-09 income year.
That measure, which has now been passed into law, aligns our rate with Australia's company tax rate. It thus improves our competitiveness with our largest export market as well making New Zealand a more attractive country from which to do business.
The new company tax rate brings with it a number of transitional and consequential changes to income tax law, most of which concern imputation credit handling in the two-year transitional period.
Without this transitional period, some companies might not be able to fully distribute the profits and associated tax credits they derived before the new rate comes into effect. These transitional changes are part of the tax bill that is before the select committee.
An associated tax rate change announced in the Budget, another to emerge from the Business Tax Review, is the reduction in the tax rate for certain savings vehicles from 33% to 30%, from the beginning of their 2008-09 income year.
As a result, people who save through entities such as unit trusts and widely held superannuation funds will benefit from the new 30% rate applying to those funds.
Likewise, many people who invest in managed funds that elect into the new portfolio investment entity tax rules will benefit from the reduction in the top tax rate from 33% to 30%.
The introduction of a tax credit for eligible R&D expenditure is a further measure to result from the Business Tax Review.
In the course of the review we also looked at the possibility of introducing tax credits for other activities besides R&D. In the end, however, we concluded that tax credits would be less cost-effective than existing mechanisms for funding areas such as export market development and skills training.
On the other hand, there is a significant and growing body of evidence that tax incentives have been effective at boosting business R&D.
The tax credit for R&D expenditure will help to bring New Zealand more into line with what happens in other OECD countries, about three-quarters of which offer R&D tax incentives.
The aim of the new tax credit is to help raise the rate of private sector R&D investment in New Zealand, which is currently only a third of the OECD average. Increased R&D investment is expected to have wider benefits for the economy and help to boost productivity and international competitiveness.
New Zealand businesses that conduct R&D in New Zealand will be eligible for a credit of 15 percent of allowable expenditure. For purposes of the tax credit, R&D is defined relatively widely, in line with the definition that Australia uses for its R&D tax incentives.
An important feature of the credit is that it will be paid out in cash to loss-making businesses such as start-ups.
The new tax credit will have built-in safeguards, to ensure that it is as effective as possible. For example, the requirement for R&D to be undertaken predominantly in New Zealand by New Zealand businesses is there because the spill-over benefits to other New Zealand firms are likely to be largest in those circumstances.
The R&D tax credit is also part of the tax bill that has been referred to the select committee.
The Budget announcement relating to the review of New Zealand's international tax rules – and specifically that the government will proceed with the introduction of a tax exemption for the active income of New Zealand's controlled foreign companies – did not get much press at the time. That is understandable, perhaps, given that the resulting changes will not come into effect immediately.
Even so, in my view, the changes that will ensue from this review will prove to have a long-term, systemic importance to New Zealand's economy.
As you may know, the review officially began with the release in December last year of the discussion document New Zealand's International Tax Review: a direction for change. It outlined the government's intention to introduce an exemption for offshore active income into New Zealand's international tax rules.
Rather than make concrete proposals for the implementation of the exemption, the discussion document canvassed the various approaches taken in other countries and indicated the broad direction and approach of the proposed reform.
Officials then engaged in an extensive consultation process with businesses.
The feedback on this consultation has been invaluable in enabling us to assemble a balanced package of reforms that suits New Zealand.
The introduction of the active income exemption will constitute a major policy change, since the offshore active income of New Zealand-controlled businesses will no longer be taxed as it is earned. Instead it will be exempt from tax in New Zealand.
At present, New Zealand is pretty much out on its own in the way it taxes all income earned by foreign companies that are controlled by our residents.
Many other countries distinguish between the active and the passive income of their controlled foreign companies. They distinguish, for example, between income from manufacturing and income from investment such as interest, dividends and royalties. And they either delay taxing offshore active income until dividends are paid or exempt it altogether.
The introduction into New Zealand of an active income exemption is intended to encourage our businesses that have international operations to compete more effectively in foreign markets. It should also reduce incentives for our companies to move overseas.
For those of you who want to know more about the international review – where it's at, where it's going and what still needs deciding – I recommend an update paper that Dr Cullen and I released as part of the Budget documents. You can find the update on the website of Inland Revenue's Policy Advice Division.
Over the next few months, as part of the continuing consultation on the international reforms, tax policy officials will be releasing a series of technical papers that cover in greater depth the topics that require further consultation and analysis
Another key plank in the United Future-Labour Confidence and Supply Agreement was for the development of a new tax rebate regime for charities.
Direct results of this commitment, as well, were announced in the Budget.
People, companies and Maori authorities will be able claim rebates and deductions for charitable donations up to the level of their annual net income, and will no longer be restricted by the present caps.
Furthermore, the deduction claimable for donations made by companies will be extended to close companies that are not listed on a recognised stock exchange.
These changes, which are also contained in the tax bill that has been referred to the select committee, are designed to provide greater incentives for charitable giving. That in turn will benefit charitable organisations and the communities they serve.
To this end, the government is also looking at the concept of payroll giving – enabling employees to make charitable donations through deductions from their wages or salaries.
Payroll giving is well accepted in Australia and other countries for its simplicity, convenience and effectiveness in promoting charitable giving. It also has the potential to increase donation levels and establish partnerships between government, employers and charitable organisations.
However, before we decide to introduce the measure, detailed consultation is necessary to ensure that it would not raise excessive costs for employers and it would be easy to administer.
For this reason, a discussion document planned for release in November will look at the implications of introducing payroll giving, and seek the views of all those concerned.
The taxation of life insurers is a further area that has been under review since last year, as you may know.
The current tax rules came into force in the late 1980s and are now out of date. The result is that many life insurers are under-taxed in relation to their profits on term insurance products. On the other hand, some policyholders are overtaxed in relation to life insurance savings products, although changes proposed in the taxation bill will reduce this over-taxation in respect of some products.
The purpose of the review is to ensure that all aspects of a life insurer's business are taxed fairly - and in a manner that is consistent with the way that other business taxpayers are taxed.
Two officials' issues papers on the review have been released for purposes of consultation with the industry, in keeping with the generic tax policy process that applies to most major tax reforms.
The suggested changes aim to tax life insurers on their actual risk insurance profits in a manner that is consistent with the taxation of general insurance. Policyholders' savings income is to be integrated, as far as is practical, within the PIE rules.
Consultation to date has shown an encouraging degree of support for the general direction of the review, with many industry representatives keen to work with officials on the detail of the changes.
As with any tax change, however, the changes under discussion have not met with unanimous approval, and my officials are eager to discuss matters with those who disagree with the reforms.
This is a very difficult tax area, but the aim is to find a solution that is commercially sensible, practical and has general industry buy-in.
I want to turn briefly to another reform introduced in the tax bill that is currently before Parliament.
That is the proposed liberalisation of tax penalties, to promote voluntary compliance, a reform that has been the subject of extensive consultation and has met with wide approval.
The compliance and penalty rules in the Tax Administration Act came into force in 1997. They were designed to promote effective and fairer enforcement of the Inland Revenue Acts by providing better incentives for taxpayers to comply voluntarily with their tax obligations.
Extensive consultation last year identified several areas in the law where those rules could be improved, and the resulting changes appear in the bill.
The bill effectively relaxes a whole range of tax penalties, such as that for taking an unacceptable tax position, so that penalties reflect the seriousness of the tax offence.
The reason for taking this approach is that people comply more willingly with the law when they see it as reasonable and fair, as is generally acknowledged.
Our current system of tax penalties does not always distinguish between people who try to do the right thing but fail, and people who have no intention of doing the right thing. That is a very important distinction.
There are also several areas in the law where the rules about what behaviour attracts a penalty could be clearer, more consistent and better targeted at making people want to do the right thing.
One of the most important of the changes proposed in the bill is the reduction in the number of penalties faced by people who have a tax shortfall if they make a voluntary disclosure before being advised that they are to be audited.
If they make a voluntary disclosure to Inland Revenue, they will not attract a penalty for not having taken reasonable care or for having adopted an unacceptable tax position. Once enacted, that change will take effect from 17 May, the date of introduction of the bill.
Related changes involve not penalising taxpayers who occasionally pay late, and updating the definition of "tax agent".
To conclude, we have a very full tax reform agenda that will provide many opportunities for businesses, individuals and professional organisations to have their say on proposed reforms – whether it takes the form of responding to ideas set out in a discussion document, making a submission on a bill that is before a select committee, or perhaps responding to informal requests from policy officials for your views on specific issues.
These contributions are an essential part of the development of good tax policy and law, and they are valued.
Thank you and I wish you a very successful seminar.