Chapter 2 - The issue of integrity
2.1 The New Zealand public values the social assistance programmes funded and delivered by the Government but requires that those programmes are accountable and that assistance is distributed fairly, reflecting genuine need. In short, the public requires integrity in these programmes. A social assistance programme has integrity if people receive the same level of assistance regardless of how they structure or receive their income. Integrity is compromised when not all of a family’s income is counted for social assistance purposes. This could be a result of the structures (for example, companies or trusts) used to conduct a person’s business or investment affairs or simply because certain types of income (for example, fringe benefits) are not included in the family’s income. Therefore, they may receive more government assistance than they otherwise would. The Tax Working Group specifically mentioned this issue in its recommendations.[3]
2.2 The definition of income is therefore important in terms of meeting the policy objective of targeting assistance to those families in genuine need of government financial assistance.
Policy framework
2.3 There are a number of possible conceptual approaches that could be taken to determine a household’s entitlement to social assistance. These approaches include: a cashflow approach based on a household’s ability to pay for day-to-day expenses, using the income tax definition of “taxable income”, and taxable income with adjustments.
Cashflow approach
2.4 One approach is to adopt a cash concept of income for social assistance purposes, similar to that used in the Social Security Act 1964. Eligibility would be based on the proportion of a family’s economic income that is actually received and spent on day-to-day living needs. In this sense, it is a family’s cash receipts that are important. Even if a family takes measures to prevent it receiving cash, that income would still be included. Cashflows would include, for example, business drawings and any distributions from trusts.
2.5 However, adopting a cash concept of income for WFF purposes would introduce an entirely new concept of income and involve significant administrative costs for Inland Revenue. Much of the information required to measure cash receipts is not currently collected by Inland Revenue. It would also impose additional compliance costs on the recipients of WFF tax credits. Moreover, the cashflow approach is likely to be an inadequate measure when substantial business or investment income is involved.
Taxable income approach
2.6 This approach would involve using taxable income calculated under the Income Tax Act 2007 for determining social assistance entitlements. The definition of “taxable income” includes salary and wage income, business profits, dividends, beneficiary income and other benefit income (such as New Zealand superannuation). It does not include certain distributions from a trust or fringe benefits.
2.7 Taxable income is aimed at reflecting “ability to pay” for income tax purposes. But a more comprehensive definition of income may be thought desirable to ensure social assistance is more effectively targeted to low and middle income families. If entitlements were based on day-to-day living needs, taxable income would be a reliable proxy for those families that rely solely on a salary or wages. However, for families receiving other types of income, using the definition of “taxable income” may not fully reflect their available financial resources.
Adjusted taxable income approach
2.8 In principle, under this approach entitlement to social assistance would be based on the proportion of a family’s economic income that is readily available for spending on day-to-day living needs. In practice, eligibility is based on the taxable income of the parents. This assumes that taxable income is a reliable proxy for economic income.
2.9 In some circumstances, such as when the majority of a family’s income is received as salary or wages, taxable income is a reasonable approximation of the economic income of the family, that is the total income available for day-to-day spending and to support family members. However in some instances it is not, notably when:
- Income is not taxed in the hands of the family, rather it is taxed elsewhere. Two relevant examples are distributions from trusts and fringe benefits. The income of a trust may be taxed as trustee income and then distributed to families tax-free and not included as family income. The employer pays fringe benefit tax on behalf of the fringe benefits received by employees.
- Income is explicitly exempt from taxation. For example, a salary from certain international organisations, such as the United Nations.
2.10 Therefore, adjustments need to be made to taxable income when it differs from the concept of the family’s economic income available for day-to-day living needs. This is the current approach to defining income for WFF tax credits purposes. However, the purpose of this reform is to improve social assistance integrity in relation to WFF tax credits, student allowances and the community services card. This can be achieved by legislating adjustments to taxable income to more closely reflect the income available to the family.
Current definition of income
Working for Families tax credits
2.11 For WFF tax credit purposes, the definition of “taxable income” in the Income Tax Act 2007 is used as the basis for calculating family scheme income.
2.12 The adjustments that are currently made to taxable income include:
- adding back certain income exempt from tax, such as child support, maintenance payments received and certain overseas pensions (maintenance or child support payments made by liable parents are deducted);
- counting distributions of employer contributions from superannuation schemes while the employee is still working for the employer;
- attributing any undistributed profits of a close company to shareholders;.[4]
- excluding any losses from qualifying companies; and
- excluding any business losses and losses carried forward from previous years.
2.13 This concept of adjusted taxable income is defined as “family scheme income”.[5]
2.14 As part of Budget 2010, losses from investments, including rental properties, will be also be excluded from 1 April 2011.
2.15 These adjustments are designed to convert taxable income (used to determine the amount of income tax a person pays) into a closer approximation of the income available to the family for daily living expenses. A more comprehensive explanation of the current family scheme income definition is contained in Appendix 1.
Student allowances
2.16 The parental income test for student allowance purposes is based on the parent’s taxable income for income tax purposes.[6] If the parent is a non-resident for tax purposes, the test includes foreign-sourced income if that income is taxed overseas. The income test for students and their partners is administered along the lines of the Social Security Act 1964 definition of “income”.
Community services card
2.17 Entitlement to the community services card for a person with one or more dependent children is based on the same definition of “family scheme income” used for WFF purposes. Any changes to family scheme income for WFF purposes in the context of this review would automatically flow through to community services card entitlement for this group.
2.18 For other groups, apart from superannuitants, entitlement is based on the Social Security Act 1964 definition of “income”. The income test for superannuitants is based on taxable income with adjustments made for overseas pensions and private pensions and annuities.
3See A Tax System for New Zealand’s Future: Report of the Victoria University of Wellington Tax Working Group, January 2010 http://www.victoria.ac.nz/sacl/cagtr/pdf/tax-report-website.pdf.
4The definition of “close company” is in section YA 1 of the Income Tax Act 2007.
5Subpart MB of the Income Tax Act 2007.
6Taxable income is the net income for the tax year after deducting any losses carried forward.