Tax pooling was first introduced in 2003 to allow taxpayers an avenue to mitigate the financial consequences that arise as a result of getting their provisional tax estimation wrong. This is done by allowing taxpayers to access better rates through approved intermediaries that arbitrage the low overpayment UOMI rate and high underpayment UOMI rate.
Tax pooling appears to be operating with efficiency and no significant issues have arisen to date. However, given the growth in the use of tax pooling by taxpayers as well as its continuing evolution, consideration should be given as to whether there are any potential risks that may not be well understood by key stakeholders.
This report considers the operation of tax pooling and provides a summary of the lifecycle of the various tax pooling transactions. It also identifies the key risks associated with tax pooling.
Overall finding of Phase One
Tax pooling is operating well and is a service and option that is valued and used extensively by taxpayers. Tax pooling appears to be achieving the policy objectives envisaged when it was developed.
Tax pooling has evolved beyond the sale and purchase of tax
Tax pooling continues to meet the policy objectives that it set out to achieve. That is, it allows taxpayers to mitigate their exposure to UOMI costs as a result of the uncertainty they faced in trying to estimate their provisional tax obligations. This is effectively delivered by the sale and purchase of tax in a tax pool.
However, additional transaction types have been developed including the provision of tax finance to taxpayers to allow them to manage cash flow issues. Tax finance was not anticipated by policy makers at the time tax pooling was first introduced. Further consideration should be given to tax finance to ensure it does not result in additional risks for Inland Revenue (IR) as well as other key stakeholders.
There is minimal regulatory oversight on tax pooling intermediaries
Tax pooling intermediaries are subject to scrutiny when they first apply to become an intermediary. However, following approval there is little regulatory oversight imposed on the intermediaries. In particular, no checks are done by IR to ensure that the tax pooling intermediary continues to meet the legislative requirements imposed under the tax legislation.
The only ongoing regulatory oversight would appear to be in relation to the anti- money laundering and countering financing of terrorism frameworks.
Consideration should be given to whether further checks should be performed to ensure the intermediaries are continuing to meet the standards set out in the legislation. For example, adequate records are being kept to provide confidence that taxpayers would be able to access their funds when required.
Further, IR should establish processes to ensure that if the legislative standards are not met, IR is aware and able to wind up the intermediary if required.
Consideration should also be given as to whether further regulatory oversight is necessary given the nature of the services that are provided.
The risk of something going wrong may be low but the consequences would likely be significant
The risk of significant issues arising from tax pooling appears to be low. This is in part due to the industry practices that have been adopted by the tax pooling intermediaries themselves, for example the use of independent trustees. However, the consequences should something go wrong would likely be significant for IR in terms of reputational risk and could extend to other government agencies. This is on the basis that there may be a potential perception that there has not been adequate government oversight over tax pooling to ensure taxpayers’ funds are protected against things such as fraudulent activities. In addition, public perception may be that any issues that arise are the responsibility of IR to remedy.
IR should therefore be clear that it is comfortable with the level of regulatory scrutiny that is imposed on tax pooling intermediaries when balanced with the level of risk and the potential consequences.
There is a lack of transparency around tax pooling
There is very limited information publically available that comprehensively explains tax pooling and the various services that are provided. While tax pooling may be understood at a conceptual level, it is difficult to access the information required to fully understand the intricacy of the services provided.
There may be legitimate commercial reasons for the lack of transparency. However, care should be taken that IR is fully informed and understands all of the services that are provided by tax pooling intermediaries.
There are some operational risks within IR
There are some risks in the way IR currently operates tax pooling. These include manual calculations being performed, a heavy reliance on certain key personnel within IR to operate tax pooling, lack of reconciliations being performed on tax pooling balances with the tax pools, and the potential for policy decisions to be made by operational staff.
IR should ensure that adequate safeguards are in place to ensure that tax pooling operates as intended. This may include IR having more oversight of the tax pooling process as a whole, as well as developing reconciliation procedures with the tax pooling intermediaries.
Difficulties in revenue forecast
Tax pooling provides challenges for revenue forecasting as funds deposited into a tax pool are not recognised as tax revenue under the current processes. As tax pooling continues to grow, the issue with revenue forecasting will only become more significant. However, it was recognised that revenue recognition for year-end purposes should not be skewed by tax pooling as all tax pooling transactions would need to have been completed before IR year end (30 June).
IR may wish to investigate whether additional information or data sharing, internally or with tax pooling intermediaries could eliminate some of the risks currently associated with how tax pooling interacts with revenue recognition.