Chapter 7 - Reforming the personal tax summary process
7.1 Most individual taxpayers’ only contact with Inland Revenue is through the personal tax summary process or when claiming a rebate at the end of a tax year. This chapter looks at the possibility of reforming the personal tax summary process as part of the wider proposals to reform the tax administration system.
7.2 The personal tax summary was introduced in 2000 and removed the requirement for individuals who earned income solely from salaries, wages, dividends and interest to file a tax return. Instead, Inland Revenue issues a personal tax summary showing gross income, taxes deducted and any refund or payment due, but only if an individual meets one of the required criteria (such as having a student loan or receiving Working for Families tax credits) or if an individual requests one. In other words, the personal tax summary provides a means for individuals to reconcile their affairs, but only if required or requested.
7.3 The end-of-year square-up process is dependent on individuals accepting the accuracy of the PAYE system. For individuals who think they might be entitled to a refund, the system allows them to request a personal tax summary to verify their tax position and, if a refund is due, it is paid into their bank account. Equally however, if at the end of the square-up process they are found to owe tax, it must be paid.
7.4 Before the personal tax summary was introduced, about 1.2 million taxpayers were required to complete an end-of-year tax return. It was envisaged that changes to the square-up process would mean that only 400,000 of these taxpayers would need to receive a personal tax summary. Therefore, the system was originally designed so that the great majority of taxpayers would be freed from the annual obligation to square-up their tax affairs.
7.5 In the paper-based environment of 2000 it was envisaged that only a small minority of taxpayers would need to contact Inland Revenue. However, changes to social policy measures such as Working for Families, and the prominence of personal tax summary intermediaries in the market, has resulted in a growing number of individuals requesting a square-up at the end of the year and an increase in taxpayer interactions with Inland Revenue. Resources that could be devoted to higher-value activities (for example, answering queries from small businesses on tax matters) are being applied to providing small refunds to individuals. While these refunds are important to the individuals concerned, the question arises whether Inland Revenue’s resources could be used more effectively.
7.6 In 2007–08, 857,000 people were issued with, or requested a personal tax summary. For 327,000 (38 percent) of this group, the error corrected was less than a $1 a week. This resulted in refunds of $3 million and assessing a further $2 million for a group that had paid $1,955 million of PAYE during the year.
7.7 To use tax resources efficiently, the Government is considering a new approach to the taxation of individuals, whereby PAYE would be treated as a final tax for many. In other words, the amount of PAYE deducted for a pay-period would represent an employee’s final tax liability on that income, providing certainty every pay-day that the correct amount of tax has been deducted.
7.8 Inland Revenue resources no longer needed for end-of-year square-ups would instead be used to ensure PAYE is deducted correctly during the year and to helping taxpayers, such as small businesses, with more complex tax matters. Improved services and products from intermediaries would also increase the accuracy of the PAYE system.
7.9 The concept of PAYE as a final tax would apply only to people in stable employment for 11 or 12 months of the year. Much of the inaccuracy within the PAYE system comes from those in part-year employment. Those who earn wages and salary income for 10 months or less in the tax year would continue to be able to square-up their PAYE at year’s end.
Margaret turned 65 in December and decided to retire. She receives New Zealand Super. In that tax year, Margaret earned $50,000, which had $11,300 PAYE deducted. She also received New Zealand Super of $4,345 which had $615 PAYE deducted.
Currently Margaret works out that her annual square-up results in a refund of $931 (because she has not worked the full year) and requests a personal tax summary to claim it.
If Margaret were treated as being subject to the proposed final tax concept, the result would be significantly negative for her as she would be unable to claim her refund. However, as Margaret has not worked for 11 or 12 months she would still be able to claim her refund, as under the current rules.
7.10 The proposal would allow the 350,000 part-year earners who currently square-up their PAYE to continue to do so. However, the year-end square-up would no longer be available for the 528,000 people who receive PAYE income for 11 or 12 months of the year.
7.11 Of the taxpayers who had PAYE deducted, $107 million (0.64 percent of total PAYE deducted) was taken from more than 570,000 people. This represents an average over-deduction of $188 (or $3.61 per week). Conversely, 890,000 people had PAYE under-deducted by $96 million (0.57 percent of total PAYE deducted) representing an average underpayment of $108 (or $2.08 per week). The remaining approximately 370,000 people had PAYE correctly deducted to within $5 for the full year. Of those entitled to refunds, about one-third did not claim their refund in 2008.
7.12 The final tax concept would not apply to groups such as those with employment-related deductions or those who are responsible for their own PAYE deductions. It also would not apply to groups that are subject to withholding tax such as casual agricultural workers or independent contractors. For those people, the PAYE or withholding payments deducted is approximate, therefore making such PAYE deductions a final tax could lead to over-taxation. The current system of annual filing would continue for these groups.
7.13 We acknowledge that ultimately the success of this approach will rely on the integrity of both the PAYE system and the employer’s overall systems for determining an employees pay, and deductions. The merits of this proposal should be considered with the longer-term view of the better future PAYE system in mind.
Treatment of other income
7.14 Employees with other income such as rents, partnership or overseas income that has not been subject to New Zealand tax would continue to file. This is to ensure that tax is paid on income that has not had PAYE deducted. So employees know the correct amount of PAYE has been deducted when they do file an annual return, the tax credit for employment income would be the amount that should have been deducted, rather than the amount that was deducted. That is, the annual return would in effect only tax their other income at the correct marginal rate.
7.15 Those individuals who receive interest and dividends which might be over-taxed would still be able to or require to square-up their tax affairs at year’s end. The square-up would be limited to interest and dividend income – that is, they would not square-up income from which PAYE has been deducted.
Bill works full-time but also earns income from a rental property. Under the proposed final tax concept he would file a tax return and have his tax calculated as under the current system. However, rather than receiving a credit for his actual PAYE deducted because Bill worked for the full-year, he would receive a credit based on the theoretical amount of PAYE that should have been deducted from his employment income.
This would ensure the correct amount of tax is paid on his rental income but he has the certainty that the tax paid through the PAYE rules is final.
Social policy entitlements
7.16 Employees who also receive social policy entitlements, such as Working for Families tax credits, would continue to square-up annually but for those who worked 11 or 12 months during the year there would be re-recalculation of the PAYE on their wage and salary income.
Questions for submitters
Submissions on any of the issues outlined in this chapter are welcomed, including:
- How would the concept of a full and final tax be best supported given the practical issues the PAYE system faces currently, particularly the increased reliance on information integrity the proposal assumes?
- Do you agree that compliance and administration costs should be reduced by ignoring small refunds and tax liabilities?
- What level of refund do you think people should forgo to enable Inland Revenue to help someone else?
- Whether PAYE should be treated as a final tax for some taxpayers where the PAYE system tends to be accurate?
- Do you think anybody needs to be added to the list of people who can still file to have their PAYE income squared-up at year’s end? The concept of PAYE being treated as a final tax should only apply to those for whom the PAYE system is very accurate.