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Inland Revenue

Tax Policy

PUBLISHED 14 March 2008

Minister of Revenue speech to IFA

In a speech today to the International Fiscal Association conference in Christchurch, Revenue Minister Peter Dunne described the extensive consultation over tax reforms that occurs under the government's Generic Tax Policy Process. He also described progress on the large tax reforms - including the reform of New Zealand's international tax rules - that have been the focus of the government's tax policy work for the last two years. For more information see the speech.

Speech, Hon Peter Dunne, Minister of Revenue
International Fiscal Association Conference 2008
Crown Plaza Hotel, Christchurch

I am very pleased to have been invited once again to open your annual conference, which is becoming progressively more important as a forum of high-level discussion on tax and fiscal policy and is the most important gathering of its kind in the year.

When I addressed your conference last year I spoke about the fundamental tax reforms that got under way in 2006 and that were to be the main focus of policy work in 2007.

They included reforms to increase productivity and growth, to make New Zealand businesses more competitive internationally and to increase personal savings and to improve the way they are used.

And 2007 proved to be an extraordinarily busy and productive year for those reforms and for tax policy generally.

2007 saw the policy development and enactment of measures resulting from the Business Tax Review, which will come into effect in a few days' time.

They are, of course, the reduced company tax rate of 30% and the new R&D tax credit, which is designed to stimulate investment into research and development by New Zealand businesses.

Last year also saw the entry into force of KiwiSaver and associated reforms, such as the now very popular PIEs, to relieve the over-taxation of people who save through New Zealand-managed funds.

It saw the introduction of related savings reforms designed to apply consistent tax rules to offshore portfolio investments in shares.

Last year's Budget announcements and ensuing legislation brought further major KiwiSaver developments in the form of the member tax credit, compulsory matching employer contributions and associated employer tax credit, as incentives for people to join the scheme.

The reform of New Zealand's international tax rules maintained momentum throughout the year.

In Budget 2007 the government announced that it would proceed with the development of an active income exemption for New Zealand-controlled foreign companies, as proposed in the earlier discussion document, and that further extensive consultation on the matter would take place.

I shall update you shortly on where we are with that consultation and with the policy development.

Further reforms of the compliance and penalty rules in the Tax Administration Act, to make them clearer, more consistent and better at encouraging voluntary compliance, were enacted.

Also enacted last year were tax incentives to boost charitable giving - removing the rebate threshold on donations made by individual and the 5 percent deduction limit on donations made by companies and Maori authorities.

These changes also come into effect this year.

Legislation introducing new regulatory and tax rules for limited partnerships, as well as updating the tax rules for general partnerships, was introduced last year and is now passing through its final parliamentary stages.

The aim of that reform is to make it easier for New Zealand businesses to attract investment capital and to compete internationally.

And finally, in this round-up of big reforms of 2007, we had the historic enactment of a massive piece of legislation that completed the 15-year rewrite of New Zealand's income tax law.

That resulted in the enactment of the Income Tax Act 2007, which takes effect next month.

I have mentioned these major developments of last year because, with the speed of reform with which we all work, it is easy to forget just how much is achieved in tax policy in New Zealand in an intensive year, such as last year was.

This year, which promises to be no less intensive, will include consolidation of a number of big reforms, policy development leading up to Budget announcements, and of course the election - in which tax is bound to feature.

Before moving on to this year's policy work, I would like to pause for a moment to look at the subject of tax rates and related matters, and then at the tax policy consultative process, whose recent death has been greatly exaggerated.

Tax rates and associated compliance matters

I take special pleasure in the fact that the reduction in the company tax rate from 33% to 30% will soon become a reality.

That reduction emanated from the Business Tax Review, a key policy plank for my party in negotiating the confidence and supply agreement between Labour and United Future.

As I have said on a number of occasions, I have long advocated a 30/30/30 approach to tax rates.

That would mean a reduction in the top personal tax rate and the trustee tax rate to the level of the new company tax rate.

Even though we are in uncertain times economically, I believe there is scope for achieving those remaining reductions, and that they would stimulate productivity, investment and personal savings, at a time when that is particularly needed.

A flatter alignment of tax rates would also deal with what might be called "integrity" issues that arise because of the difference in the company tax rate and the top personal and trustee tax rates.

If we were to have a flatter alignment, however, it would be doubly important to ensure the robustness of the tax base, and that all involved pay their proper share of tax.

My colleague the Minister of Finance has said that further tax cuts will be considered in the context of this year's Budget, and in my role as Minister of Revenue I will be working closely with him on the development of those.

Corporate tax base

An important part of maintaining robustness of the tax system overall is to ensure that all companies, large and small, pay their fair share of tax as well.

That is especially important in New Zealand, where we seem to be more heavily dependent on our corporate tax base than are many other countries.

For example, in New Zealand in 2005, taxes on corporate income made up 6.3 percent of GDP, which put us in second place, after Norway.

Similarly, OECD figures for corporate tax as a percentage of total taxation for the same year had us again in third place, at 16.8 percent, following Norway and Australia.

That said, other tax administrations share our concern to protect the corporate revenue base in these increasingly borderless times.

That can be seen in collaborative efforts such as work done on harmful tax competition by the OECD and European Union in recent years.

One of the main items on the agenda for the OECD's Forum on Tax Administration, held in Cape Town in January, was new trends in global business and wealth management and the implications for revenue bodies.

The forum was attended by Revenue Commissioners from over 40 countries, including New Zealand.

Their joint communiqué, issued after the forum, emphasised that modern tax administrations should work with large businesses, at board and senior management levels, to ensure that tax compliance receives proper consideration in corporate governance.

Accordingly, our own Commissioner of Inland Revenue, Bob Russell, and other senior Inland Revenue officials have been conducting meetings with large businesses as part of the department's tax compliance strategy.

Another important part of Inland Revenue's approach is to have closer collaboration with revenue authorities in countries that are New Zealand's main trading partners.

Generic Tax Policy Process

To turn to the government's Generic Tax Policy Process - the GTPP, which is on your conference agenda, I am told that it is assured a lively discussion here.

The GTPP has, of course, been much in the news lately, with some firms claiming in the media that it has been abandoned.

At this point I would like to make it clear that the GTPP is alive and well.

Last year alone the government produced eleven tax policy discussion documents and issues papers that sought people's views on a wide range of tax changes, all involving significant change to the policy framework - such as the changes proposed in the Business Tax Review, the review of our international tax rules, and the review of the taxation of life the life insurance business, to cite just a few.

In response to those many consultative documents last year, we received over a thousand formal submissions.

And that occurred well before the proposed changes were incorporated into a bill, and obviously does not include the submissions that are invited later when a select committee considers the bill.

Very few countries allow that degree of consultation on law changes.

When the government considers fundamental change to the tax policy framework, which sometimes involves a complete change of direction, it consults widely before making final decisions on the matter and drafting it into legislation.

However, when changes are needed within the existing framework - perhaps to deal with an anomaly, an ambiguity, unintended consequences, uncertainty or a significant fiscal risk - the government may choose to deal with the problem by announcing that the measure, once enacted, will apply from the date of announcement, and that it will consult with interested parties on the details of the legislation before it is included in a bill.

Interested parties will have a second opportunity to express their views to the select committee that considers the bill.

Changes of this kind may involve some sort of grand-parenting whereby transactions entered into before the day of announcement will not be affected by the forthcoming change.

These announcements are not much used.

They make up a very small percentage of the many tax changes that are announced and enacted each year.

Furthermore, Ministers do not make them lightly, and when they do they must carefully balance competing factors such as commercial and market sensitivity against the need to protect New Zealand's revenue.

To engage in wide consultation before announcing the closure of a loophole or the blocking of a scheme that is losing New Zealand millions of dollars in revenue would risk creating enormous uncertainty.

If the government were to announce that a certain business tax change might or might not be made following extensive consultation, what should people running businesses do in the meantime?

Should they make an educated guess on which way the decision will go, and if they prove to be wrong suffer the tax consequences?

Tax advisers might have the edge in guessing, but even they would suffer uncertainty.

And what if they advise their clients incorrectly, as it turns out?

It is preferable in these situations, I believe, for the government to provide that much needed certainty by announcing that a legislative change will be made and the date from which it will apply, and as much detail as possible.

Absolute certainty would be provided by overnight legislation, but we have to balance that against the desirability of consultation on details.

Hence we generally prefer to consult on the details of a change before it is drafted into legislation.

It seems to me that you can have one or the other: this type of announcement, possibly with some form of grand-parenting from the date of announcement, or you can have extensive consultation before the announcement, with no grand-parenting.

New Zealand's tax policy consultative process has an excellent reputation overseas and is often cited as a "best practice" model.

If you want to know more, I recommend reading the 2007 report to the Treasurer of the Australian Board of Taxation on improving tax consultation in Australia.

The board has done an international investigation of tax consultation systems and cites the New Zealand system in some detail.

The report cites a number of factors that make our successful process more suited to us than to Australia, however.

They include the skills of our tax policy officials, the small size of the tax community, a national "predisposition towards public consultation", and a more positive approach taken by our financial press to tax matters.

Reform of international tax rules

An excellent example of the GTPP process in action can be found in the government review of New Zealand's international tax rules.

The public phase of the review started in December 2006 with the release of the discussion document New Zealand's International Tax Review: a direction for change.

The discussion document announced the government's intention to introduce a radical change for New Zealand's international tax system - replacement of the current system of accrual taxation with an active income exemption.

We recognised that a change of this magnitude needed the broadest possible consideration and consultation.

It was for this reason that the discussion document canvassed the wide variety of approaches that other countries have used in implementing their systems rather than present a definite proposal.

Our intention was to allow a full and thorough discussion with businesses and their advisors so that a system consistent with New Zealand's business realities could be developed.

To this end, the Minister of Finance and I asked our policy officials to meet directly with companies and members of the accounting and legal professions to discuss the design of the new system.

Over the period of the review, we have put out the May Budget Update and a number of issues papers that have made detailed refinements to the proposals as a basis for deeper discussion.

It should be apparent to those members of the audience who have been part of this process that the details of the proposals have been heavily influenced by our discussions, and I assure you that they continue to be so.

Not surprisingly, everyone enthusiastically supports the active income exemption and the proposal to exempt dividends.

And I think it is fair to say that almost everyone understands the need to tax passive income and generally agrees with our approach in this area.

There are two areas, however, where the level of support has been, shall we say, less enthusiastic - the extension of interest allocation rules to firms with outbound investments and the replacement of the grey list by the 5 percent active business test applying in all countries.

The goal has been to provide New Zealand businesses with flexible rules that facilitate their expansion overseas.

At the same time, the rules must protect the New Zealand tax base.

With regard to interest allocation, we received from the consultations a strong message, loud and clear, that substantial tightening of the rules, such as lowering the 75 percent threshold or removing goodwill from equity, would be neither possible nor desirable.

We have not pursued these possibilities.

However, the move to exempt active income fundamentally changes incentives for companies to allocate interest expenses.

We continue to believe that interest allocation rules are needed in this new environment.

The grey list is perhaps a more difficult area.

In proposing to replace the grey list, we have set ourselves the challenge of developing a simple test that will remove truly active businesses from the burden of attributing small amounts of passive income.

A number of features to this end have already been announced.

They include, for example:

  • choice in the use of accounts or tax data in applying the test;
  • consolidation of the test within a jurisdiction; and
  • an internationally limited definition of passive income.

And Ministers continue to listen.

From the most recent round of discussions, we have learned that some features of our proposed rules for taxing royalties and base company income would be burdensome and could inhibit active businesses.

Changes are probably possible here.

There is another area where change in the proposals may also be necessary.

A recurring theme in officials' discussions with accounting firms has been a concern for the impact on SMEs, particularly those investing into Australia.

We share this concern.

Legislation to implement the first phase of the international tax review is scheduled to be introduced in late June.

It has already been announced that there will be a second phase of the review.

It will move to extend the active income exemption to non-portfolio foreign investment funds and overseas branches, an extension that has been encouraged by many of the people who have been consulted on the review.

We will be consulting later this year on how best to achieve this.

The consultations have raised a number of other issues that will be dealt with in the second phase of the review.

A number of submissions suggested that there should be a relieving mechanism for non-resident withholding tax on dividends paid to non-resident shareholders if those dividends represent distributions of exempt active income.

Australia has rules along these lines.

This can be an important issue for New Zealand-based multinationals with non-resident shareholders, and it will be explored as part of phase 2 of the international tax review.

While there appears to be policy merit in providing such an exemption, fully exempting the dividend would require confidence in the level of base protection provided by the new CFC rules.

Base protection measures include taxing passive income above the 5 percent threshold and application of the interest allocation rules.

Consultations have revealed that a number of New Zealand-based financial institutions have active businesses offshore.

Extending the active income exemption to such businesses will be explored in the second phase of the review.

In conclusion, I want to thank all the companies and their advisors who have taken the time for meetings and making detailed and thoughtful submissions.

They do matter, Ministers do listen and our tax system is greatly improved by the process.

Double tax agreements

As part of the review of our international tax rules, the government has also been looking at lowering withholding tax rates in our double tax agreements.

In the discussion document published in December 2006, as part of the consultative process for the review, we noted that there may be a case for reducing those rates.

Implementing this new approach to non-resident withholding tax will make renegotiating treaties with our major trading partners a key priority going forwards.

In some cases changes may be made through negotiating amendments to existing double tax agreements, but in others a full renegotiation of the treaty may be more appropriate.

This programme of renegotiating some of our double tax agreements will kick off this year, with a full renegotiation of our Australian treaty beginning in early April.

Life insurance reform

The government review of the life insurance tax rules is making good progress.

We received eighteen submissions on the proposals set out in the December discussion document, which is a good number for such a highly specialised area.

Most submissions generally agreed with the direction of the reforms, which is to bring the tax rules up to date with developments in the industry over the last 18 years.

Fair taxation is the aim, for both policyholders and life insurers.

Several submissions did, however, raise a number of industry concerns, including concern about the proposals for participating policies and other savings policies, as well as about transitional losses.

Ministers are considering all these concerns and, in the meantime, I can confidently say that the reform is on track for inclusion in the June taxation bill.

Payroll giving

Ministers will soon be in a position to decide on whether to introduce a voluntary payroll giving system whereby employees can have their charitable donations deducted from their pay by their employers.

Feedback from consultation on last year's discussion document confirmed that there is strong support for the concept of a voluntary, before-tax payroll giving system for New Zealand.

We received 36 submissions from a wide range of people and organisations.

Most thought that payroll giving would make it much easier for employees to make regular, voluntary contributions to their chosen charities, and would also provide charities with a low cost, on-going source of funding.

Furthermore, some businesses see the introduction of payroll giving as part of their corporate responsibility.

Even so, there was concern about the potential compliance cost burden on employers.

My view is that it is important that any such system that is implemented in New Zealand enables employers, employees, and charitable and other non-profit organisations to establish schemes that best meet their individual circumstances, and allows them to manage the associated costs.

Imputation review

Policy work on the imputation review continues, with the government expecting to release a discussion document soon.

The review will examine how well the current imputation system is aligned with the policy principles that lay beyond its original introduction.

The review has arisen because of the increasing pressure that is being placed on the imputation allocation provisions.

Companies with unused credits may have an incentive to find ways to transfer them to other taxpayers if they would have greater value in their hands.

One aim of the review is to provide greater clarity in the determination of which transactions are counter to policy and to ask whether changes to the current imputation rules could better reflect policy intentions.

It is also necessary to review the matter of refunding imputation credits, in response to continued calls from the charitable sector for it to be able to use them.

Any possible changes to the imputation rules will need to be measured against the underlying principles of the imputation system.

The compliance and administrative costs of any changes will also need careful consideration.

Consultation with New Zealand business will play a critical role in determining the final form of resulting proposals.

Income splitting

A government discussion document on income splitting for families with children will be released this year.

In most countries, income splitting is a matter of allowing couples to lower their total tax liability by allocating some of the higher earning partner's income to the lower earning partner, in this way mitigating the effects of the progressive tax rate scale.

Along with providing additional support to families with children, income splitting may also give parents more choice in combining their working and caring roles.

This discussion document will investigate whether income splitting for tax purposes would be an effective way of further supporting families with children, if further support is desired.

If submissions show strong support for income splitting the government will look at developing detailed proposals for further consideration, though that would not occur until early 2009.

GST base maintenance

GST anti-avoidance matters will be the focus of another consultative document to be issued next month.

Our GST system is much lauded by the rest of the word for its comprehensiveness and simplicity.

It deserves its reputation as a model for a pure GST-VAT system.

It is, nevertheless, not without its problems.

Tax policy officials are working towards the release a technical issues paper about the GST treatment of transactions involving the supply of high-value assets.

The paper will discuss ways of improving business-to-business neutrality in GST and cover a range of topics including "phoenix" entities, which are a particular concern for all countries with a GST or VAT system.

It will also present a range of options for dealing with schemes whose central feature is that, because of differing GST accounting bases, one person gets a GST refund, while the other pays no offsetting output tax.

Non-disclosure right

To update you on progress on having the non-disclosure right for tax advice apply to discovery in litigation proceedings, which accountancy firms would like to see happen, policy officials have now consulted with a number of interested parties on the matter and reported to Ministers.

As you know, the right in relation to tax advice was enacted in 2005 to provide a degree of consistency for tax advice with the privilege enjoyed by lawyers.

Ministers are now considering the matter, and if all goes well I hope to see the amendment in the next taxation bill.

To conclude, I've spoken a lot today about the use of consultation in tax policy development.

That is because I place great value on its use in producing policy and legislation that work. I would like to express my appreciation of the contribution to that process of the many individuals, firms and professional associations who take the time to express their views on proposed reforms, many of whom are represented here today.

Your contributions are valued.

With that, I'll wish you a very successful conference.

Thank you.