Appendix 3 - Business tax
3.1 Initial feedback (including from the Tax Administration for the 21st Century conference, and from business groups) has primarily focussed on a need for speed, predictability, resolving issues with provisional tax, and low business risk in business taxation matters. Inland Revenue should use new technology to allow more focus on high-value services to taxpayers, to help enable them to better manage their tax affairs.
3.2 This, together with a desire to see improved compliance levels and lower tax compliance costs (which are seen as deadweight and unproductive to the New Zealand economy), are key factors to consider in any business tax changes.
3.3 It is important to consider, and develop further with relevant stakeholders, what the key issues are. Businesses want access to the right people at the right time to ensure that the business is doing the right thing. Are there aspects of running a business that present specific issues – such as the impact of taking on more staff or other key events? Although thinking in the business tax space is less developed currently than for other areas being considered, the scope of any change investigated will likely involve developing responses to the following issues:
- What are the actual tax compliance issues being faced from a business’s perspective – for example, what is the real scope of the problems being considered?
- How big are these problems and what are the relative priorities?
- What would the impact be if these problems are not solved?
- The potential cost implications of any possible solutions.
3.4 Although this Green paper explores, at a high level, some initial issues for feedback reflecting initial concerns raised by businesses, the Government is particularly interested to find out if there are other, or more important areas of focus that would deliver the most benefits to business.
3.5 It is worth restating that, wherever possible (and appropriate), any proposed business tax changes should fit within the existing broad-base, low-rate tax policy framework.
3.6 In addition to the policy framework considered in Appendix 1, there are other more specific objectives for potential business income tax changes that should result in the following outcomes:
- reduced overall compliance and administration costs for businesses and the Government;
- better voluntary compliance;
- a high level of predictability for taxpayers;
- effective and timely solutions to taxpayers’ pressing issues and problems (for example, when providing binding rulings);
- where possible and appropriate, have a low cost of contact;
- be designed for a digital world, not a paper world, using existing business processes wherever possible;
- work in a way that helps prevent tax debt arising in the first place, while efficiently allowing for its recovery when this is not possible;
- provide good information so that key policy concerns and audit risks can be identified easily, recognising that businesses that are low risks should have lower information requirements;
- collect revenue as companies earn their income without imposing excessive compliance costs on taxpayers;
- provide value-for-money for the Government; and
- be flexible enough to cater for future changes.
3.7 The issues briefly explored as part of this Green paper are:
- In relation to provisional tax, in particular exploring whether there are more effective, or more certain, methods available for calculating and paying provisional tax.
- Exploring ways to simplify interactions with small businesses, to reduce compliance costs and provide more assistance to these businesses.
- Moving away from the current focus on detailed tax 'returns' to a concept where the focus is instead on providing key information, and this information is provided digitally, in a way that fits the size and nature of individual businesses.
3.8 Initial feedback indicates that the calculation and payment of provisional and terminal tax currently presents a number of problems for many businesses.
3.9 While acknowledging that there are pressure points associated with the payment of provisional tax, it is important to reiterate that, to the extent possible, it is desirable that firms pay tax as their income is earned. This is consistent and equitable with the way in which other taxpayers are taxed, and is necessary to ensure government finances are effectively managed.
3.10 The fiscal implications of any changes will need to be carefully scrutinised when assessing the merit of any changes.
3.11 Also, the design of any changes will have to be very carefully worked through with businesses and their advisors, so that any impacts on businesses’ cashflows can be fully considered.
3.12 The process of paying provisional tax should be as painless and easy to comply with as possible.
3.13 There is an inherent trade-off between the accuracy of the payment of business income tax as income is earned, and compliance costs.
3.14 The calculation and payment of provisional and terminal tax currently presents a number of problems for both businesses and Inland Revenue. Key amongst these are:
- use-of-money interest risk for businesses, resulting from the need to estimate annual tax liabilities part-way through a year of assessment for provisional tax purposes;
- compliance costs associated with estimating liabilities before the year of assessment has ended. Initial feedback has centred around a desire for businesses to be able to focus more on growing their businesses rather than estimating future tax liabilities; and
- the one-off square-up nature of terminal tax can present cashflow difficulties for businesses, in particular, because of the nature of the current rules for new businesses. This also has knock-on effects for Inland Revenue in its enforcement activities.
3.15 Any changes ultimately proposed for provisional tax should take into account, and balance, the following specific objectives and considerations:
- To the extent possible, provisional tax payments should align with when and how firms generate their cash flows.
- Where appropriate, businesses should be able to rely on existing business processes and technology (for example effective third-party accounting software providers).
- The impact that any change has on encouraging compliance – making it easy to comply and difficult to get wrong.
- Compliance cost savings for customers.
- The impact that use-of-money-interest on underpayments has on businesses.
- Helping to prevent businesses from falling into tax debt.
- The need for the Government to effectively and responsibly manage the country’s finances – for example, fully consider the fiscal implications of any change.
- Equity issues between different customers.
Initial options for consideration
3.16 In the future, the calculation and payment of business income tax could be done more 'on account' as income is earned during the year – akin to a PAYE for businesses. This has the potential to simplify the calculation of provisional tax and create more simplicity for taxpayers.
3.17 More use of interim accounting calculations, rather than the more difficult task of estimating the actual taxable income for the year, could better align to a business’s own processes.
3.18 This is an example where, as with other parts of this Green paper, innovation through the private sector (for example, through third-party accounting/tax software providers) could be an important ingredient in ensuring that any potential changes are successful.
3.19 The review could consider whether accounting profits with a very few key adjustments (for example, reversing out capital gains and losses and excluding non-taxable income etc.) could effectively be used as a proxy for provisional tax in practice. As noted above, accounting software packages would likely have a key role to play in developing options in this area.
3.20 Another potential proxy that could be investigated, at least for some taxpayers (such as SMEs), would be to develop a simplified system whereby provisional tax payments are based on a percentage of a business’s turnover. Systems improvements could potentially allow for a bespoke provisional tax rate to be calculated based on a business’s previous tax position.
Use-of-money interest and penalties
3.21 Issues relating to UOMI and penalties are inevitably closely related to provisional tax concerns. The following paragraphs discuss specific areas of focus that are likely to form part of the review of provisional tax.
3.22 Currently, individuals using the standard uplift method for calculating their provisional tax obligations are not subject to UOMI if their residual income tax is less than $50,000 (referred to as safe harbour taxpayers). This only applies to individuals at present, not to other entities. Options for change to safe harbour limits that could be considered include:
- providing safe harbour for taxpayers using new payment calculations (as discussed above) – for example, for certain businesses using such calculations on approved software; and/or
- increasing the existing monetary threshold ($50,000) for those using the standard uplift option. It should be noted that this change, in isolation, would merely take more individuals into the safe harbour limits, not other business entities; and/or
- in order to bring other businesses into the safe harbour net, the safe harbour limits could also be extended so that they also apply to non-individuals when using the standard uplift method. This would mean that entities with residual income tax of less than $50,000 (or some other criteria) would no longer be subject to UOMI throughout the year.
3.23 Another option could be to look at the current standard uplift methods available to taxpayers more generally – for example, a review of a combination of uplift rates, safe harbour limits and payment dates.
3.24 UOMI rates could be re-considered, in particular in relation to overpayments of tax (the current rate of interest for overpayments is 1.75%). One of the reasons customers spend a lot of time on their provisional tax calculation may be because they do not want to overpay and receive a perceived low interest rate if they pay more than is required.
Increased use of tax pooling
3.25 Tax pooling allows taxpayers to pool their provisional tax payments in order to arbitrage better rates than standard rates of UOMI provide. A review of provisional tax would also therefore investigate whether changes could be made to the tax pooling rules to see if they can be improved and/or made available to more taxpayers in practice.
3.26 Any residual issues relating to terminal tax could be addressed by rolling outstanding tax liabilities into future provisional tax payments, rather than by separate one-off payments.
‘Tax bank’ / tax accounts
3.27 Some individuals or businesses might want to make regular tax payments, or to put money aside as they earn income, to make sure they have sufficient to meet future tax liablilites.
3.28 A potential area for investigation is whether there should be some sort of organised 'tax bank' – in effect, a tax account where taxpayers could make regular deposits that would be held on account to meet tax obligations as they arise.
3.29 Timing and perceived ownership would be important factors in this process. Where tax is regularly provisioned and settled with Inland Revenue, this would most likely promote compliance. However, if tax is regularly provisioned, but the money sits in the account for an extended period, customers would likely perceive the funds as belonging to them. This would likely lead to decreases in compliance as customers would perceive the funds as being available for other purposes.
3.30 A product of this nature would not necessarily need to be managed by Inland Revenue – it could instead be managed by appropriate third parties. This could potentially allow businesses and intermediaries to innovate an efficient solution to meet market needs.
3.31 Given the large number of small and micro businesses in New Zealand, and the fact that this sector bears a large proportion of overall compliance costs, making tax easier for this group is a real priority. Compliance costs are also higher for smaller businesses compared with larger businesses which tend to have better tax understanding, better financial systems and better business processes.
3.32 Many small businesses have poor financial systems and business processes which affect their ability to meet their tax obligations. Poor business systems are one of the causes of the following compliance problems with small business taxpayers:
- under-reported income;
- errors (for example, incorrect classification of capital expenditure, claiming private expenditure as business expenditure, or failure to make trading stock adjustments); and
- failure to register for tax types, file tax returns, and make tax payments on time.
3.33 Public feedback from the Tax Administration for the 21st Century conference indicated there are opportunities for Inland Revenue to be more proactive, sophisticated and agile in how future business tax and advice is provided to these businesses to get it right from the very start of their business operations.
3.34 It is important that taxes are not a minefield for small businesses – complying should be easy. It may be that there is assistance that Inland Revenue could provide to specifically help achieve this, including encouraging the use of improved business systems and accounting software that meets specific standards to ensure the first few years of a business’s lifecycle are successful.
3.35 Other forms of assistance could involve ensuring that the right support is available at key events that may result in tax obligations, such as taking on new staff for the first time.
3.36 Ensuring that businesses get it right first time and maintaining that level of compliance will be a focus of any on-going changes in this area.
3.37 The overarching objective of any changes to the tax rules for small and micro businesses should be to improve compliance levels, reduce compliance costs, and encourage improved business systems, while maintaining the Government’s revenue from this sector.
3.38 The following objectives should also be taken into account:
- using customers' normal business processes and systems to meet tax obligations and lower their compliance burden;
- making it easy for small business customers to comply, and difficult not to;
- improving predictability for micro and small business customers; and
- reducing the following compliance issues for small and micro businesses:
- under-reported income;
- errors; and
- failure to file tax returns and pay on time.
Initial options for consideration
3.39 In addition to general efforts to improve compliance and reduce the time and effort required of small and micro businesses to deal with their tax affairs, a specific option that could be explored further is encouraging small businesses to use accounting software that meets Inland Revenue standards.
3.40 Small businesses are very diverse and feature a range of different business models, so any such software would need to capture a number of different transactions and systems.
3.41 The type of software envisaged would capture transactions from the customer's business and automatically transfer these to the customer's accounting records and tax return. The software would have features to help users correctly classify transactions. For new micro and small businesses these features should allow them to meet their tax obligations correctly from the very start of their business operations.
3.42 Businesses that use the software would benefit from greater certainty as the types of difficulties they currently face from errors and misclassification would be reduced. This would:
- reduce the level of under-reporting by automatically capturing transactions;
- reduce the number of errors by assisting customers to classify transactions;
- increase filing on time through automated processes; and
- reduce customer effort by aligning with their normal business processes.
3.43 This option could be supported by changes to the penalties rules. The current penalties rules are based on associated shortfalls arising from individual transactions. Where appropriate, the rules could be adjusted to instead focus more on the processes and systems of the customer, thus encouraging customers to remedy systems faults which give rise to tax shortfalls.
3.44 This option would also further enable Inland Revenue to focus its top-end interactions (investigations etc.) away from post-return audits on individual businesses towards greater focus on systemic issues within high-risk sectors or industries.
3.45 Small business may also benefit from tax rules being simplified. By ‘simplified’ the Government does not mean introducing tax concessions for small businesses. Tax breaks for a particular group or industry are likely to create distortions by encouraging resources to flow into less productive activities, solely to get the tax break. This is inconsistent with the BBLR framework previously discussed in Appendix 1.
3.46 However, it may be possible to make some changes that result in tax simplification for small businesses that reduce compliance costs and make it easy to comply without a substantial fiscal impact.
3.47 The provision of information from businesses to Inland Revenue currently focuses on a detailed one size fits all tax return and associated disclosures. This Green paper explores placing more focus on instead providing key information, in a digital form, in a way that suits the size and nature of individual businesses, and the government.
3.48 Currently, a tax return is based on the provision of a paper 'return'. These typically have three main purposes:
- providing updated factual information (for example, address and other contact information);
- providing information to support decision making – such as information for policy or audit targeting; and
- providing the final top-level calculations of a taxpayer’s tax liability, for checking by Inland Revenue.
3.49 Physical tax returns, in particular for businesses, is out-dated in a digital world. It does not add value to either Inland Revenue or businesses.
3.50 Businesses are often forced to duplicate processes in order to comply with return requirements. This increases compliance costs and can cause errors in transposing information from one form to another. The information required may also be out of synch with the business’s size or risk profile.
3.51 On the other hand, from Inland Revenue’s perspective, current tax returns may not be providing the type of information from businesses that would most effectively allow it to carry out its debt recovery and audit functions. There is also an efficiency cost to Inland Revenue in processing non-digital and/or superfluous information.
3.52 Digital technology provides an opportunity to rationalise current tax returns for non-individual entities more efficiently where the focus is on providing relevant up-to-date information in an efficient manner.
3.53 The focus of any such shift should be to best utilise businesses’ existing processes and systems to make it easier for businesses to provide their information to Inland Revenue.
3.54 Further, the focus on information provided should be more focussed on information that is necessary to support Inland Revenue in higher value matters – such as helping improve customers’ compliance, better targeting of audit activities, informed policy advice, risk evaluation, and pre-population of income for other taxpayers.
3.55 Introducing a differential reporting approach to the company income tax return would also reduce the reporting requirements for the majority of non-individual entities, and would be in line with recent changes to financial reporting requirements. Smaller businesses, which often have disproportionately high compliance costs, would ideally have to produce significantly less information.
3.56 Finally, any review should also ensure that:
- information received from, or in relation to, new businesses starting up is fit-for-purpose and received in a timely fashion;
- the rules around when binding rulings can be provided (for example, as part of the assessment process) are also fit-for- purpose.