Government's tax policy agenda outlined
In a speech today in Christchurch to the International Fiscal Association, Finance and Revenue Minister Michael Cullen outlined the Government's tax policy agenda for the year. Major issues include the Tax Review; the taxation of private superannuation fund savings; tax deductions for R&D expenditure; "triangular taxation"; GST and imported services; tax simplification; and interest deductibility for companies. For details see the Minister's IFA speech.
Speech to the International Fiscal Association 24th Annual Conference
Dr Cullen's address to IFA NZ BRANCH 24th annual conference, Millennium Hotel, Christchurch
It is a pleasure to be able to take part in your conference again this year, at this, your twenty-fourth annual gathering.
I addressed your association last year, as the new Minister in charge of the Finance and Revenue portfolios in what was then a very new government. Since then, we have been busy fulfilling some core election promises. We are proud of what we have achieved. Keeping our word has been our guiding principle. This administration is bringing back accountability to government.
We are putting in place policies to achieve social and economic stability and to modernise the economy. Today I want to discuss how the tax policy agenda will complement our vision to lift our economic game.
Before describing some of the main tax policy projects and issues that we are going to be tackling this year, I want to assure you that major policy issues will be dealt with in accordance with the Generic Tax Policy Process. That process is not just about full consultation - it is also about building understanding.
In formulating tax policy proposals, the government needs to understand private sector concerns and views. And the private sector needs to have the same chance to understand how what is being proposed fits into an overall, coherent set of policies. I am committed to building that understanding. The most important event in the tax area for the coming year will undoubtedly be the Tax Review.
The tax system is a fundamental determinant of economic prosperity so it was vital that we have reviewers of the highest calibre. I am very pleased to have been able to assemble such a depth and breadth of experience on the panel. I am certain that they will make a significant contribution in helping us make sure that the tax structure meets New Zealand's current and future needs. A comprehensive brief has been give to the independent Review that allows it to consider all relevant options.
One of my key objectives in setting up the Review is to create a forum for debate and discussion of the important tax policy issues facing New Zealand. The Review sends a challenge to all people with a stake in the tax system to think long and hard about what they want to tax or not tax.
I hope people will rise to that challenge and we can see an informed and constructive debate.
Outside the Tax Review, the Government is proposing a busy policy agenda in 2001.
The agenda we are pursuing, amongst other things, include the following:
- reducing compliance costs for business
- support for exporters
- attraction of investment for growth
- active business development policies
- the promotion of human capital and
- lifting our savings performance.
Taxation and savings
Turning now to specific issues, the most important on the government's agenda, and one that will be occupying a great deal of my time this year, is the passage of the New Zealand Superannuation Bill. At present, that bill is under consideration by Parliament's Finance and Expenditure Committee.
The scheme that the bill proposes is a straightforward one which, through partial pre-funding, establishes a secure basis for long-term provision of the first tier of retirement income. Our scheme, by introducing certainty and by maintaining the universal nature of the present system, will encourage private savings for retirement.
This brings me to the central tax issue of the matter, the way that savings for retirement through private superannuation funds are taxed. There are arguments for and against changing the present system. My view is that the tax system could do a lot more to encourage people to save for retirement, and this year I intend to foster an informed policy debate on the matter.
My preference at this point is to move from taxed-taxed-exempt to taxed-exempt-taxed for the taxation of superannuation savings. The TET model reduces the effect of tax the longer savings remain in the fund, as savings accumulate free of tax. This would definitely benefit long-term savers, depending on the level of taxation imposed upon withdrawals.
In moving to such a system, however, we would have to consider the likely fiscal implication, in that the revenue we are currently receiving by taxing this investment income as it is earned by the fund would be deferred until the funds are withdrawn years later. Adopting the TET model would defer receipt of something like $500 million a year initially according to official estimates. The debate must take into account any fiscal impact.
R & D
As part of the government's commitment to encouraging private sector research and development, last year saw a new grants programme and increased funding for Technology New Zealand. We chose a grants approach to support R & D because we considered it more effective than tax concessions. The grants programme has been running for about five months now, with grants totalling $8.6 million on their way to more than 140 successful applicants so far.
In the meantime, tax practitioners and business people pointed out the current tax treatment of R & D lacks certainty, especially in the distinction between capital and revenue R & D expenditure.
We then issued a discussion paper setting out a proposal that would allow businesses an immediate tax deduction for R & D expenditure if it is deductible under the accounting standard FRS 13.
In other words, the proposal aligns the tax law on R & D with accounting practice, which would make most research and development expenditure immediately deductible.
We are now considering the submissions that we received on the proposal. Although many of the submissions regarded the proposal as a useful step forward, most argued that the government should go further and introduce an immediate deduction for all R & D. The most commonly advocated alternative to FRS 13 was the 'Frascati' approach.
I understand the objective. The issue is whether the 'Frascati' definition will achieve what its proponents expect of it, and whether it will actually deliver more than the FRS 13 approach.
Both definitions provide 100 percent deductibility for what the industry categorises as R&D so there is no difference between the two regimes in that respect. But the 'Frascati' definition will be more expensive to run, as it will impose significantly higher compliance costs.
That is the advice I have received from my officials - and from ICANZ.
The Institute's preliminary assessment is that "there will not be huge differences between the scope of these respective definitions". But it does think there will be a significant difference in compliance costs. It says, "a significant saving in compliance costs results if the same analysis is required for both tax and accounting purposes."
This is only to be expected. The 'Frascati' definition comes from an OECD manual on how R and D should be measured for statistical purposes. It is unlikely that many tax advisors would be familiar with the Frascati definition.
There appears to be growing support in New Zealand for not following the Australian model on the tax treatment of R & D. That model sounds attractive at first, but on closer examination it appears to introduce a great deal of complexity into the law and might, in fact, result in fewer deductions for R & D than under our proposal.
It is important to the government that we have an environment that encourages innovation and investment in a skilled workforce. In the R & D area this means tax rules that do not discourage expenditure in research and development, and that are as simple and certain as possible.
I hope that proposals for such tax rules can be included in the bill to be introduced later this month.
I would like to talk now about progress on the perennial issue of trans-Tasman tax. Triangular taxation, as it is known, occurs when an Australian company pays tax in New Zealand, yet is unable to provide imputation credits to its NZ shareholders. This effectively means that New Zealand shareholders are taxed twice on the same income. The reverse applies in Australia. New Zealand companies pay tax in Australia, yet cannot provide franking credits to their Australian shareholders, who are taxed twice on the income.
Successive governments have tried to resolve this problem, which requires a bilateral solution. The solution, when found, will obviously benefit both countries and will no doubt enhance CER. Reducing distortions to investment decisions between our two countries can only help our combined capital markets. Resolving the triangular taxation problem will benefit both countries in the long run.
So what progress have we made? Late last year my officials met with their Australian counterparts to discuss the matter, and to consider options. That work continues, and I am in correspondence with Peter Costello about it. I trust that by our June deadline I will have something more concrete to report.
The continuing increase in electronic commerce presents both opportunities and challenges for tax administrations everywhere. It can improve the delivery of services provided by tax administrations, while at the same time requiring them to manage possible risks that it poses to the revenue.
On the policy front, New Zealand is participating with the OECD to refine the model double tax agreement to take account of electronic commerce.
This activity has included the recent clarification of whether a website or server can give rise to a permanent establishment.
The Government will soon be releasing a discussion document on GST and imported services in the light of the growth in electronic commerce. It will take into account the OECD's current work on consumption taxes and electronic commerce. Proposals will deal with the rationale and practical implications of introducing a reverse charge, or system of self-assessment, on imported services. The discussion document will be followed by a review of the GST treatment of financial services.
Tax simplification is very high on the government's agenda. My conviction that we need a great deal more simplification, especially for small businesses, has been reinforced time and time again in discussions with business people around the country.
It is not helpful to the economy to have our business people spending a disproportionate amount of time and energy worrying about how to meet their tax obligations. Instead, we want them out there running their businesses and making money. We need to make it easier for them to pay their tax. The government's programme for tax simplification is an integral part of our overall strategy for reducing business compliance costs. It is intended to sit alongside the work being done by the Panel on Business Compliance Costs, chaired by Alan Dunn.
Tax simplification and compliance cost reduction are the special interest of the Associate Minister of Revenue, Paul Swain, and you will be hearing more from both of us on this matter.
Within the next three months we are planning to release a series of discussion documents that tackle some of the complexity of the tax system from different angles.
One discussion document will focus on simplification proposals for small businesses. It will look at removing the unnecessary risks that employers and businesses face because of the way the tax system has evolved. I am thinking here, for example, of risks that a tax payment may be calculated incorrectly, or that a payment is late, both of which can lead to undue stress and penalties.
We are looking at ways of reducing these risks by making calculations easier for taxpayers and more efficient, and aligning tax payments with patterns of income receipt. We also want to use new technology to find innovative solutions to reducing compliance costs and risks.
Compliance and penalties
Another discussion document will approach tax simplification from the perspective of tax penalties, the point of which is to increase voluntary compliance. The discussion document will set out proposals arising from the review of the legislation enacted in 1997. The review, which began a couple of years ago, has also taken on board certain recommendations of the Finance and Expenditure Committee's inquiry into the powers and operations of Inland Revenue.
The review is concentrating on how well the objectives of the relatively new legislation are being met, including whether it has resulted in changes in behaviour. It is also looking at whether the rules are understandable and fair, and perceived as such by taxpayers.
Consultation on the review of the tax disputes resolution legislation, enacted at the same time, is set for later this year.
A third discussion document in the simplification series will look at the somewhat antiquated rules governing the taxation of Maori authorities, which can sometimes lead to double taxation. The discussion document will set out proposals for removing problems and simplifying the tax rules.
The discussion document will also set out proposals for clarifying the "public benefit test" for charitable status to provide more certainty for Maori entities seeking charitable income tax exemption.
Rewrite of the Income Tax Act
A major part of the tax simplification package is the forthcoming exposure draft of the rewritten Parts C, D and E of the Income Tax Act, along with a commentary explaining the changes. I understand that a session of this conference is devoted to the rewrite.
The principle behind the rewrite of the Act, which is, of necessity, a long-term project, is that legislation that is clear, written in plain language, and is structurally consistent makes it easier for taxpayers to identify and comply with their tax obligations. This is common sense.
The release of the first draft of Parts C, D and E for public comment, the result of several years' work on the part of drafters, and much consultation, will constitute an important milestone for the project.
I hope that those of you who have an interest in the legislation will take advantage of the opportunity to comment, and submit your ideas for further improvements.
Simplifying and clarifying the rules on interest deductibility for companies has, as you may know, been on the tax policy work programme for a long time.
In September 1999 the previous government released a discussion document that contained two main proposals. The first was that interest incurred by most companies would be deductible unless the thin capitalisation and conduit interest allocation rules applied. The second proposal was for the safe harbour debt to assets ratio in the thin capitalisation rules to decrease from 75% to 66% which was considered to be more commercially realistic.
The Australians released an overview of their interest package at the same time ours was released in September 1999. Last week they released the detail of their thin cap rules. Given that we should be cautious about moving in a different direction, it seems unwise to proceed New Zealand's thin cap safe harbour ratio decrease as was originally proposed.
There is also the question, however, of the detail of the thin cap calculations, where there are differences between what Australia is doing and what our current rules are. In particular, the Australians exclude from their thin cap asset base certain equities held by Australian companies in foreign entities. To the extent these foreign entities do not cause Australian tax to be paid this is logical.
I have concluded that we should exclude similar investments from the New Zealand asset base for thin cap purposes.
Officials have undertaken preliminary consultation on this option, which has raised some real concerns amongst those consulted. In line with the Generic Tax Policy Process, further consultation on the detail of this is necessary. Given the concerns expressed, I have asked officials to prepare an issues paper on the "how" issues as a basis for further consultation.
The effective date for the core interest deductibility proposal will be from the start of the 1 April 2001, or equivalent, income year. It will be enacted as part of the next tax bill. The thin capitalisation change should be effective from income years actually beginning on or after 1 April 2002. Legislation for this will be introduced later this year.
I would like to wind up today by turning to Inland Revenue's soon to be announced new taxpayer charter. The main impetus for a new, updated charter was a recommendation of the Finance and Expenditure Committee in its 1999 report on the powers and operations of the department.
Since then, Inland Revenue, led by the new Commissioner David Butler, has put a lot of work and consultation into developing a document that describes the principles that will underlie IRD's working relationship with the public. It will set out what taxpayers can expect from the department, including their right to question the service they receive if they think the department is not honouring the charter.
It will also set out the standards of service the department will aspire to, a major commitment, given the millions of contacts Inland Revenue has with the public each year. As many of you are tax practitioners, I trust you will welcome the charter as a valuable tool in your working relationship with the department.
I wish you a very successful conference. Thank you.