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By Jordan Bond, RNZ
The taxman thinks top earners are likely to report nearly $3 billion less in income after a new tax bracket above $180,000 is introduced, with officials fearing people will shift money around to avoid paying.
The Inland Revenue Department (IRD) says people can “structure” their tax affairs to reduce the amount they pay.
The IRD warns that the current policy does not meet the government’s objectives, as structuring can “erode public confidence in the integrity of the tax system“.
And based on final tax returns for the year, it could cost the government about $150 million in tax revenue over the past year.
Effective April 1 of last year, personal income tax over $180,000 a year was reduced from 33 to 39 cents on the dollar. It was one of Labor’s 2020 election policies, which the party said was to generate revenue while affecting the country’s top 2% earners.
The corporate income tax remained the same at 28 cents, as did the trustee income tax rate at 33 cents.
The Inland Revenue specifically warned ministers that people would try to avoid paying the higher personal rate unless it brought the rates of other commercial vehicles, especially trusts, in line with the higher personal rate .
John Cuthbertson, head of local taxes in Australia and New Zealand, said the greater disparity opens up the possibility for high earners to reduce the tax they pay.
“The potential is that some people will find the temptation too great and seek to mitigate their tax affairs to pay less tax.”
He noted that the difference between the business flat rate of 28% and the highest personal rate of 39% is now 11 percentage points.
“It basically creates fertile ground where [high income earners] start thinking “that’s actually a big disadvantage now, is there a better way to do this legitimately?” and pay less tax as part of the process,” Cuthbertson said.
To try to calculate this, Inland Revenue focused on high earners in recent years who would likely be affected by the new 39% $180,000 rate in the 2022 tax year.
(Although the tax year at the time was not even complete, the IRD was able to piece together rough estimates of income.)
He expects returns for this group to be down $2.88 billion, or about 14%, from a year earlier.
The IRD expects the average self-employed person – who has the most control over their income – to report income 13% lower than the previous year, from $191,000 to $166,000. This would bring them under the $180,000 threshold and not pay the higher rate.
The number of PAYE earners is expected to decline and also report lower earnings, dropping from an average of $228,000 to $217,000.
The IRD stressed that these were initial estimates based on incomplete data and that the year’s filings will not be complete for at least 12 months. It was also very likely that the Covid-19 related disruptions had an impact on revenue, but this was also the case for tax year 2021, which is the comparison year.
However the IRD has historical suspicions to believe that a structuring took place.
The following chart shows the steep spikes in income reported by the self-employed just at the threshold where the marginal tax rate increases to $48,000 and $70,000.
Since the government was elected, with the promise to lift the highest personal tax rate, the IRD noted that the number of trusts and corporations had increased by 28%.
“This, combined with estimated revenue movements, raises concern that structures could be used to reduce revenue below $180,000,” the tax department said.
A Deloitte tax partner, Robyn Walker, thinks it’s too early to jump to conclusions.
She said it’s not all “tax driven”, and there are perfectly legitimate reasons why someone’s income has plummeted, especially with Covid.
“When you’re a business owner, more often than not, you may be the person who pays last,” Walker said.
“I would hesitate to say that the decline in income for this population is necessarily due to a reaction to the introduction of the 39% tax rate, and potentially more to a reaction to the fact that Covid-19 has caused enormous disruption .”
The IRD told government ministers – revenue, David Parker and finance, Grant Robertson – that any structuring that happened would have adverse effects.
“The perception of arbitrary results, such as when some taxpayers may structure themselves to avoid the 39% rate, will erode public confidence in the integrity of tax systems and the sense that all taxpayers are treated fairly.”
In 2020, IRD officials unsuccessfully recommended that the government also raise the tax rate for trustees to 39%.
“Integrity risks can be mitigated…by imposing a 39% rate on trustees’ income, since trusts are the primary vehicle that high-income taxpayers are most likely to use to divert income that would otherwise be taxed at their personal rate of 39%,” the officials wrote.
“An increase in tax rates will generally lead to more tax-induced structuring activity, as it becomes relatively more attractive for taxpayers to try to circumvent the 39% rate. This will likely lead to disputes with tax payers. taxpayers seeking to avoid the new rate and possibly courts.The Inland Revenue is already undertaking significant compliance activity to minimize avoidance and will expect the incentives created by higher taxes to create more pressures in this domain.
A spokesman for Revenue Minister David Parker said they were monitoring this closely.
“When we introduced the 39c rate, we always said that we would monitor the situation and the use of trusts, and act if necessary,” the statement said.
“That’s also why we’ve introduced powers to collect information from trustees to better understand trust behavior.
“Inland Revenue will manage its resources as it sees fit to act on the information and protect the integrity of the tax system.”
The government is consulting this month on ways to limit the avoidance of higher tax brackets using a corporate structure.
John Cuthbertson, the accountant, said they shouldn’t rush into a resulting decision.
“I think the last thing we really want or need here is some kind of knee-jerk reaction. We’ve already dramatically increased the compliance burden for everyone, and we want to be very careful that if they’re considering extend these integrity measures that they do not infringe on normal and routine business practices in New Zealand,” Cuthbertson said.
The IRD said it was keeping tabs on this.
“We continue to monitor trends and patterns, focusing on customers who had high incomes in the 2021 and/or 2020 tax years, as this is the population that can be motivated to change behavior at during the 2022 tax year to minimize their exposure to the 39% tax rate,” said Tony Morris, IRD’s Head of Client Segment.
“There are many other reasons why a client could have had a high income in 2020 or 2021 and a valid reason for their income to be lower in 2022, for example people who retired or were made redundant in 2020/ 21.
“Where we identify behavior that indicates a client has attempted to avoid the highest personal tax rate, we engage with those clients to understand the reasons for any changes in their income and/or income structure. their business.”