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Making tax simpler - A Government green paper on tax administration

Appendix 4 - Withholding taxes on capital income

4.1 As income from savings and investments is likely to grow in the future – as the population ages and more capital is accumulated – it will become more important to ensure that such sources of income, and associated resident withholding tax (RWT) deducted at source, are accurately and promptly recorded.

4.2 A review of the current RWT rules and practices is planned follow and build on improvements arising from more effective and streamlined collection of PAYE information. This would look to enhance the provision of information relating to, primarily, RWT arising from interest and dividends. This would be achieved by integration with existing business processes (similar to the process envisaged for an improved PAYE information-gathering process).

CURRENT PROBLEMS

4.3 Where applicable, Inland Revenue currently receives information from financial institutions on RWT on an annual basis. There are, however, problems with the way this information is received and used:

  • Annual RWT systems are often slow, and often inaccurate, meaning further information and subsequent square-ups from customers are frequently required.
  • Administration and compliance costs are high, in particular in relation to the benefits realised.
  • There is duplication of compliance from entities recording and deducting RWT, customers and Inland Revenue.
  • RWT systems cannot be used as effective debt recovery tools.

4.4 In relation to dividends, Inland Revenue does not currently receive timely or effective information on dividends payments that are made.

4.5 For interest received, taxpayers can select the RWT rate they believe their interest should be taxed at. When a clearly incorrect tax rate is chosen (for example, one that is not at the margins), this will often result in tax being underpaid (or overpaid), leading to difficulties and extra compliance for customers to make up the shortfall or otherwise rectify.

4.6 Alternatively, issues can also arise in correctly identifying income from joint accounts or sources.

POTENTIAL CHANGES

Objectives

4.7 The fact that Inland Revenue does not have good information on capital income, or alternatively does not receive or use it in a timely manner, means it is not able to assist taxpayers in assessing their tax rate or completing their income tax returns (if required). Improvements in the way that RWT operates should help facilitate wider changes to the ways Inland Revenue interacts with individual customers (see Appendix 5).

4.8 However, effective collaboration with financial institutions and other businesses deducting RWT will be essential to ensure that any RWT changes are successful and, in particular, to ensure that overall compliance costs are efficiently managed. This means:

  • Information should ideally be processed automatically as part of existing business systems, for example, when payments are made (or another suitable time), rather than as part of a separate return. The information then becomes an integral part of the business system, rather than a separate process.
  • Business systems should interact directly with Inland Revenue (and vice versa), with up-front validation of information.
  • Upfront validation of information could ensure that the correct amount of tax is paid throughout the year. This could in turn reduce the number of customers who have tax to pay at a later stage.
  • Upfront validation would also potentially allow RWT systems to be used as an efficient method of collecting underpayments of tax.
  • Inland Revenue would be able to use the information to pre-populate 'tax returns' to inform details of customers’ gross income and tax withheld (and social policy entitlements).

Likely scope of review

4.9 This review would look at:

  • The timeliness of information provided to Inland Revenue – could information be provided at the time income from capital is made or soon after the year-end, rather than later or not at all.
  • The type of information provided (for example, should Inland Revenue receive information on capital balances)?
  • How the requirement to provide information could be incorporated into normal business practices, thereby reducing compliance costs.
  • Whether information could be validated when received by Inland Revenue. This would allow for proactive advice that a different tax code might be more appropriate.
  • Whether RWT systems could be used as a debt recovery tools, for example, by using variable withholding rates.
  • Whether changes could remove the need for financial institutions to provide annual tax information to customers, as they would already be provided directly to Inland Revenue.
  • The compliance cost burden that would be faced by financial institutions and businesses deducting RWT.
  • What alternative processes could be put into place for businesses that cannot incorporate real-time information provision into their normal business practices.

4.10 Consultation with financial institutions and other businesses deducting RWT will be essential to ensure that any RWT changes are successful. In particular, consideration should be given to institutions that may also be subject to other changing information requirements (for example, in relation to the OECD’s Automatic Exchange of Information proposals) who will need to consider the timing and impact of the changes.

4.11 The review should also consider the potential application of withholding tax on other sources and forms of capital income – for example, on approved issuer levies, Maori Authority distributions, portfolio investment income and royalty payments.