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Inland Revenue

Tax Policy

PUBLISHED 15 October 2004

Michael Cullen speech to ICANZ

In a speech today to the annual conference of the Institute of Chartered Accountants, Revenue Minister Michael Cullen covered the economic outlook, revenue flows and the latest tax policy developments. For more information see the Minister's speech.

Hon Dr Michael Cullen
Deputy Prime Minister, Minister of Finance, Minister of Revenue, Leader of the House


Address to ICANZ 2004

Christchurch Convention Centre, 63 Kilmore St, Christchurch

Thank you for inviting me to speak at your annual conference. I would like to touch upon a number of issues that I think will be of interest to you all: the economic outlook, growth in revenue flows, recent base maintenance developments and, by way of examples across the tax arena, the way in which carefully thought-out tax policy can contribute to the government's overall goals.

The overall picture has been one of economic growth, with the first half of 2004 stronger than forecast by Treasury and others. Economic growth for the year to June was 4.4 per cent. The domestic economy, especially private consumption, continues to be the driver of growth and residential and business investment. Growth in private consumption eased in the June quarter, but consumption overall remained at a high level.

The momentum in the domestic sector of the economy is likely to maintain growth at a higher rate than forecast in the Budget Update over the remainder of 2004. However, activity is still likely to slow from its recent rate as a result of higher interest rates, increased oil prices and a slowdown in the housing market, with expected growth of 2.5 per cent in the year to March 2006. This would be only a mild slowdown and reflects the momentum in the domestic economy and the fact that the negative factors are expected to be relatively mild.

International oil prices have reached record levels in nominal terms recently as a result of strong demand and disruptions to supply. While prices may have increased to a higher underlying level, the recent spikes have been caused by temporary supply factors and so are not expected to persist. New Zealand has benefited from the strong world demand for a range of goods and services, even though this has boosted oil prices. But persistent higher oil prices will lead to lower world growth, lower export returns for New Zealand and higher import prices.
These economic fundamentals mean that we are well placed to react to the changing world economy and fluctuating prices.

Taxation growth has reflected the strong performance of the New Zealand economy. In the year to June 2004, tax receipts grew by $2.8 billion, or 7.1 per cent. Most of this growth came from source deductions, company tax, and goods and services tax.

Source deductions receipts grew by $1.4 billion, or 8.9 per cent, reflecting a very strong labour market, with over 3 per cent growth in both employment and wages for the year to June. Net company tax receipts grew by nearly $900 million, or 17 per cent, well in excess of operating surplus, which at budget time was estimated to grow by 1.6 per cent for the March 2004 year. And goods and services tax grew by $700 million, or 8 per cent, driven by increased consumer spending and residential investment.

There has been much comment recently concerning fiscal outturns and the government's supposedly overflowing coffers. You would not expect me to let this opportunity pass without setting the record straight.

The Crown financial statements for the year ended 30 June 2004 recorded an operating balance surplus of $7.4 billion (5.3 per cent of GDP) and an OBERAC (Operating Balance Excluding Revaluations and Accounting Changes) of $6.6 billion (4.7 per cent of GDP).

Although this is an excellent result, it does not mean it is all cash that is just sitting around in a bank account, because:

  • $1.3 billion was used on capital purchases such as new machines for hospitals, building new roads and prisons;
  • $1.7 billion was used for loans – such as those made to students and District Health Boards;
  • $1.9 billion was put aside to save for future New Zealand Superannuation costs;
  • $1.2 billion represents the non-cash element of the OBERAC such as surpluses retained by SOEs and Crown entities which they can use for future investment.

Once these have all been accounted for, the Crown's cash surplus for the year was $520 million.

The solid performance on the revenue side for a number of years has enabled the government to fund increases in health, education and infrastructure spending, as well as the 'Working for Families' package announced in the last budget. This investment in our society is not only socially good but also necessary to keep us an attractive destination for highly skilled migration.

Healthy revenue has enabled us to make this investment while maintaining a sound fiscal position. That means we are better placed to withstand any external economic downturn because we can put aside funds to help cover the future costs of our aging population. Providing for known future pressures, investing in the country's infrastructure and building a sound fiscal position demonstrate the government's sound planning for the future.

Some commentators have suggested that the government should regard the non-cash element of the surplus as available for distribution to taxpayers. This simplistic analysis ignores the government's fiscal goals, notably our long-term fiscal objective of gross debt as a percentage of GDP slowly reducing over the longer term and passing through 20 per cent of GDP by 2015.

As an historian, I am bemused that some commentators seem to see responsible fiscal management as somehow inconsistent with a Labour government. However, responsible fiscal management coupled with responsible social investment was the hallmark of the First Labour Government from 1935 to 1949. New Zealand's was probably the only government whose financial position at the end of the Second World War was in better shape than at the beginning of the conflict.

The reason for this fiscal discipline was quite simple – members of that government had not only seen but had experienced how the most vulnerable suffered most from lack of fiscal prudence.

Our fiscal position does now give the government some room to manoeuvre on the tax policy programme. I am not prefiguring across-the-board tax cuts. This government will not put future New Zealanders into debt by chasing some illusory nirvanas on the Laffer Curve. But sensible reforms that have previously been ruled out because of their fiscal cost can now be considered. An example of that is the savings issue that I will come to shortly.

To maintain healthy revenue flows requires continuous application of base maintenance and protection measures, across the spectrum of business activity.

Recent months have seen announcements by banks about Inland Revenue reassessments associated with their offshore investments, the High Court cases concerning so-called "mass marketed schemes", and the Queenstown property audits. Obviously, I am not involved in any of these matters but I have ensured that Inland Revenue has been funded to enable it to police the tax system in a balanced way.

I have also encouraged tax policy officials to bring forward proposals to keep our tax laws robust. The ingenuity of some in this audience is truly astonishing, and it has required the normal stream of legislative responses. Recent examples have been:

  • enactment of the deferred deduction rule, which is targeted at mass-marketed schemes,
  • closing a loophole relating to the sale and leaseback of intangibles such as newspaper mastheads,
  • and closing another relating to the dividend tax rules that allowed investments in certain unit trusts to be tax-free.

A major item in the next month's taxation bill will be new thin capitalisation rules for banks. They are a response to the fact that, in recent years, bank profits have continued to increase, whereas the tax they have paid in New Zealand has not followed the same trend. A major reason for this, I am advised, is that foreign-owned banks have been entering into structured finance arrangements whose income is essentially not subject to tax in New Zealand, but involving large deductions for interest and associated expenses taken against New Zealand income.

The proposed thin capitalisation rules will require such investment to be funded by equity, or some of their interest will not be deductible. The estimated tax to be collected by these changes is $360 million a year, which is significant in anyone's terms.

At the other end of the scale are the problem industries, composed mainly of small operators, where "cash jobs" and tax evasion are ingrained. We have recently released a discussion document proposing limited amnesties as a targeted measure to bring those evaders who are willing back into the tax system. A limited amnesty in an industry would be accompanied by stepped up Inland Revenue audit of the industry.

When I first became Minister of Revenue I said that I intended to maintain the rational tax system that New Zealand enjoys. On the other hand, I also said that we would not be dogmatic in our tax policy. The primary purpose of tax policy is to raise revenue fairly and efficiently, but this still leaves room for flexibility in the interests of broader social, economic and environmental objectives. Tax-related growth and innovation measures to aid good business outcomes, social cohesion and base maintenance continue to be central themes in the government's tax policy work programme.

As you are all no doubt aware, encouraging private savings is an area high on the list of government priorities. Economically sound savings will occur only if the tax rules governing different kinds of investments are as neutral as possible. As you will probably know, however, the current tax rules for savings are far from neutral.

For onshore savings, very different tax rules and results apply, depending on whether someone saves directly or through a savings vehicle. And if the savings vehicle route is taken, different tax rules apply, depending on the vehicle.

For offshore savings, the situation is, if anything, more confusing. An investment in a 'grey list' country yields a particularly benign tax result and can provide tax planning opportunities, while the same investment in a 'non-grey list' country is taxed in full.

Needless to say, the tax rules for savings are in need of an overhaul, but it will need time, given the complexity created by the number of savings vehicles available and questions about the level at which taxation should occur – for example, whether at the fund or saver's level. For this reason, it is very important that officials work with the savings industry to see whether what is desirable is, in fact, achievable.

With this in mind, in August the government initiated a wide-ranging consultation process with stakeholders on problems with the taxation of investment income, both onshore and offshore. Craig Stobo has been consulting widely and will report his findings to me later this month, a report that I hope to release publicly early next month. I look forward to his report, as I imagine do many of you in the audience today, and I am hopeful that it can form the basis for comprehensive reform.

If we can get the rules relating to the taxation of savings right, some of the disincentives to saving will be removed, thereby creating a good platform to develop measures to increase work-based savings for retirement. Several ideas for increasing savings schemes in the workplace were put forward in the recent report to the government of the Savings Product Working Group, which recognised the importance of first getting the tax side right.

I intend bringing these various pieces of work together so that in the 2005 Budget I will be able to provide a clear outline of future reforms in the savings area. I said earlier that our fiscal position gives us some room to manoeuvre. This is a good example of that.

Contrary to the approach used in some past, failed attempts to address savings issues, I am prepared to consider options to solve these problems that are not fiscally neutral. This does not mean, however, that I support tax concessions for the savings industry. In my view, the international evidence is overwhelming that they do not work. I am attempting to reduce distortions in the area rather than to increase them. I also remain concerned that such incentives benefit those already saving rather than generate new savers.

I would be astonished, however, if sensible reform could be achieved without reducing the overall tax take, and I intend to promote sensible reform. It is obviously premature to speculate now on the detail of such reforms. However, from my discussions with Craig Stobo and with members of the savings industry, an imperative seems to be to remove the tax on capital gains levied on savings through actively managed unit trusts and super schemes when it is not levied on individual investors or passive funds. This seems both unfair and inefficient – unfair because in practice a harsher tax treatment is likely to apply to small investors and inefficient because it represents an implicit tax on the use of institutional savings.

I do not want to pre-empt Craig Stobo's report, but I would be very sympathetic to changes along these lines.

Another key objective for the government is keeping New Zealand an open, dynamic economy, one that does not hinder access to capital or misallocate it. Again, good tax policy can make a positive contribution here, by reducing the extent to which the tax system is a barrier to growth and innovation.

If firms are to thrive and grow to the optimal level they need access to capital. The government is looking at various measures, including tax-related measures, to reduce barriers to firms accessing finance.

We have already acted to remove a tax barrier to unlisted New Zealand companies accessing offshore equity finance, a measure that features in the taxation bill currently before Parliament.

Under the proposed legislation, offshore tax-exempt investors and foreign funds of funds from countries with which we have double tax agreements will be exempt from tax when they sell share in unlisted New Zealand companies. The change targets offshore institutional investors – such as US pension funds, which provide much of the world's venture capital. Once enacted, it will apply from 1 April this year.

To get capital investment right we also need to get the tax depreciation rules right. I have been concerned for some time that the rules may discourage investment in shorter lived assets, especially high tech assets for which obsolescence is a key problem, in favour of longer lived assets like buildings. The recent officials' issues paper on the rules looked at ways of reducing possible tax biases and resolving technical problems. It elicited a lot of submissions, which are being analysed at present.

The next step is for officials to complete their formal recommendations to me on how the rules should change in order to achieve better investment outcomes. Although these are early days in the process, I expect that we will eventually end up with faster depreciation rates on shorter lived equipment and slower rates on buildings. Any such rebalancing will not boost overall tax rates on investment income and will reduce artificial tax biases.

As part of a package of measures to boost gas exploration over the next five years, the government announced in August that it will introduce legislation to remove a tax obstacle to gas exploration and development. The '183-day-rule', which can create inefficiencies and detrimentally affect operations, will be lifted until late 2009 for non-resident, offshore rig operating companies, drilling rigs carrying out gas field development work, and seismic survey ships involved in exploration. The legislation will be part of the taxation bill to be introduced next month.

The government is also moving to reduce tax barriers to international recruitment to New Zealand of people whose skills are in demand throughout the world. A discussion document published late last year proposed benefiting businesses that recruit overseas workers by reducing some of the latter's tax costs – in this case, by introducing a temporary exemption on their overseas income. The policy development of the proposal has been completed, and it awaits Cabinet sign-off for inclusion in a bill next year.

Although possibly the least brilliant star in the tax firmament, tax simplification has a key role to play in growth and innovation, by freeing businesses to concentrate on what they are there to do. Simplification is not glamorous, perhaps, because it seems always to be with us – continuous but never finished, composed of series of small steps towards something that may never be completely achievable. No single solution can fit all, and each proposed change often has as many detractors as supporters.

The latest series of proposals for making tax easier for small business is working its way through the policy development process. The taxation bill now before Parliament introduces one of these, a 6.7 per cent discount for self-employed people who make voluntary payments of income tax at any point during their first year of business, to reduce the financial strain of paying two years' tax in their second year of business. This proposal has enjoyed a relatively wide measure of support, both in early consultation and in submissions on the bill.

The next round of changes will be introduced next year, and then the government will be consulting with you again for more ideas on further simplification initiatives.

To diverge slightly, although tax was not a factor in the survey, New Zealand cannot be doing too badly overall if the World Bank has rated us top of a list of 143 countries for 'ease of doing business' – ahead of the US, Singapore, Hong Kong and Australia.

If we want to keep our profile as a good place in which to do business and to invest, we need to keep abreast of international tax developments. Our closest relationship is and will continue to be with Australia. I have been pleased with the progress made in working with Australia on the tax front at both the ministerial and officials' level.

Although Australia is a close colleague, it is also a competitor for international investment and business. We need to ensure that we continue to implement sensible reforms and, if possible, maintain an edge. The changes to venture capital tax rules that are before Parliament way are an example of this focus, which will be maintained. I have, for example, directed officials to look at whether New Zealand should adopt limited liability company rules, along the line of those of the US, which allow companies with separate legal status to be treated as partnerships for tax purposes.

In fostering an innovative and productive New Zealand, economic and social objectives must also be balanced against environmental objectives.

Next month the government will be introducing legislation to clarify and improve the law relating to the tax treatment of environmental expenditure – such as costs for preventing, remedying or mitigating the discharge of contaminants. The proposed changes have so far been welcomed by business and environmentalists alike.

The proposed changes will allow costs for dealing with environmental problems to be taken into consideration when businesses calculate their taxable income. For example, a voluntary site restoration fund will be introduced so that business taxpayers can obtain tax deductions and refunds for restoring contaminated sites. Businesses will have the option of making contributions to the fund that will reduce their tax liability. Refunds, which will be taxable, will be given on cessation of business to help meet restoration costs.

Moving to a larger environmental issue, I see that the effect of the Kyoto Protocol, which will come into force internationally once it is passed by the Russian Parliament, occupies a major slot on your conference's programme. It is therefore timely for me to re-state the government's policy on a future charge on emissions of greenhouse gases.

The government's policy is to introduce an emissions charge on fossil fuel and industrial process emissions no sooner than 2007, to create incentives to reduce emissions. The charge will approximate the international emissions price but be capped at NZ$25 a tonne of carbon dioxide equivalent.

The government has retained the option of introducing emissions trading as an alternative to an emissions charge if the international carbon market is reliable and the price is reliably below the NZ$25 cap.

Revenue resulting from the charge will be recycled into the tax system. This means a carbon charge will not increase the overall tax burden, but will be offset by tax reductions elsewhere. The amount of money involved is not large relative to the overall tax take. I am only now beginning to look at some of the options, but across-the-board tax cuts are unlikely.

The government's recent announcement that it would introduce legislation extending statutory privilege to tax advice provided by advisors such as chartered accountants has been welcomed by your Institute. Because of the importance of the measure to the Institute, the government agreed to include it in the taxation bill to be introduced next month. The reduced timeframe means that although a lot of policy development has already gone into the proposed legislation, more may be required at the select committee stage. I would encourage you to take part in that process so that the resulting legislation is robust and workable.

As regards the government's review of fringe benefit tax, I would like to assure you that we have considered what submissions on the discussion document have said. The most contentious issue – except, perhaps, the existence of FBT itself – is car parks. We recognise the need to explore ways of achieving better policy consistency while keeping compliance costs to a minimum, and trade-offs have to be made. There is no intention that the review be a revenue-gathering exercise. While fringe benefit tax is, in effect, a tax on employees' non-cash remuneration, its application needs to be consistent with an environment that is conducive to efficient business.

For example, the current treatment of work-related vehicles is anomalous as it relies on the type of vehicle rather than the use to which it is put – we are looking at how this can be improved. On car parks, the provision of a car park is clearly a fringe benefit to an employee who uses it regularly, but there are several associated, thorny issues – ultimately we need to consider whether the benefit is of sufficient magnitude to warrant the costs of measuring and taxing it – we have no intention of imposing extra costs on businesses for the sake of it.

We are looking at introducing changes in a bill next year.

To conclude, 2004 has been a very, very busy year on the tax policy front, as you will know, and next year promises to be at least as busy.

A highlight of the year will have to be the enactment in May of the three-volume Income Tax Act 2004, which was a milestone for the team who began the progressive rewrite of income tax legislation in the early 1990s. Again, consultation on the rewritten legislation with the tax community was a vital part of the exercise, and the contribution greatly appreciated by the government.

Another highlight of the year was the highly co-ordinated response across government agencies and Parliament, and the significant contribution made by your Institute and Federated Farmers to recovery efforts in the wake of the February storms. It was all extraordinary and appreciated, by myself and other government ministers, but in particular by those whose lives, farms and businesses were disrupted by the disaster. I shall end this speech by thanking all of you who helped bring the recovery effort together.

I wish you all the best for a very successful conference.