Chapter 3 – Scene setting: the shift to digital

3.1 The shift to digital, that is transactions or processes happening through digital channels, is the fundamental concept driving our view of the future and provides the context for this issues paper.

3.2 Efficiency, convenience, and effectiveness are factors underpinning the development of a more digital economy, with COVID-19 providing an added spur. We see no reason for this shift to slow and we anticipate that digital channels and systems will become even more dominant.

3.3 Transactions happening digitally is not new. What is influential, however, is the extent to which complete business systems are online. It is the shift to businesses operating digitally, rather than undertaking some digital transactions, that is important.

3.4 Inland Revenue too is providing an increasing amount of its services and functions online. Thanks to the Government’s investment in business transformation, the revenue system now operates on a digital platform and Inland Revenue can interact online with taxpayers, payment recipients and a range of intermediaries and business partners.

3.5 Inland Revenue, however, is not driving the shift to digital. Adapting tax and social policy systems to facilitate digital interaction is about keeping up with how people are living their lives and doing business. Equally, failure to adapt presents risks that the tax system would negatively affect revenue raising, integrity and fairness.

3.6 New Zealand is not alone in moving in this direction. Across member countries of the OECD, we see – with variations in focus or pace – a consistent pattern. These are summed up in the OECD’s Tax Administration 3.0: The Digital Transformation of Tax Administration.[4] In mid-2020, the United Kingdom’s Her Majesty’s Revenue and Customs released Building a trusted, modern tax administration system[5] which canvasses many of the same issues and suggests heading in the same direction as described in this issues paper.

3.7 There are similar themes in policy development within other government departments. Examples include the Strategy for a Digital Public Service[6] and the Digital Strategy for Aotearoa.[7] This latter strategy is motivated by the world we live in becoming more digital and ensuring that New Zealand can leverage the economic and social advantages of innovative technologies.

3.8 Work within government to establish the consumer data right is relevant to the issues explored in chapter 5 about sharing data. Development of the Digital Identity Services Trust Framework,[8] which the Department of Internal Affairs is leading, is building towards a trusted system of digital identity which will be a key ingredient of the tax and payments system.

What a more digital tax system means

3.9 Increasingly smaller companies are using software to run their business, particularly to manage their financial record keeping, invoicing and calculation of tax obligations. They are spending less time on the more routine aspects of accounting and tax and are freed up to focus more on running their business.

3.10 The shift of business management into digital channels means tax calculations can be embedded in the software businesses use. This is referred to as tax occurring in the business’s natural systems.

3.11 The effect is that meeting tax obligations becomes a by-product of non-tax processes. This is a paradigm shift for taxpayers and tax administration. Compliance is built in. It reduces the scope for errors and options for non-compliance (though still reliant on the quality of data that is inputted), while also reducing the burden of compliance arising from using different processes for taxation and other aspects of business.

3.12 Exactly how this will play out in terms of details and pace is unknown, as it will be driven by private sector innovation and uptake by taxpayers. This issues paper considers what foundations are needed to allow the system to evolve.

3.13 Not all people and businesses will adopt digital ways of operating and some will continue to self-service for tax. However, there are already signs of new products and services being developed which give us confidence that the uptake of digital processes will continue to grow. Examples we are aware of include:

• Financial intermediaries who provide accounting software and automate much of the tax calculation for self-employed contractors.
• Platforms that provide job matching services, but which also manage payment and tax deductions.
• A software developer whose focus is on lower income people who might struggle to maintain control over their finances. Via an app, an accurate picture of people’s financial circumstances is developed by compiling information from various sources and this is used to provide tailored services, such as budgeting or prompts when significant payments are due.

What the future could look like

3.14 A fully digital tax and payments system would involve the administration of that system being integrated in broader economic systems. People would grant and manage consents to the party or parties they want to represent them or manage their tax affairs and with whom they are comfortable having their data shared. Processes would be streamlined through there being one source of truth for data and information – participants access this data when needed rather than there being separate data repositories that need to be reconciled. Inland Revenue is often, but not always, the holder of this information. Inland Revenue’s role would evolve to ensure a seamless boundary between it and external parties. Inland Revenue partners with external parties to manage risk and ensure the integrity of the tax and transfer system.

3.15 Aspects of this system are in place. For instance, external parties already play a major role in the system supporting taxpayers. A more digital world will, however, shift the nature of these entities’ involvement with the taxpayer and the tax system.

3.16 The vision is also idealised. It will need to be adapted as risks and tensions emerge between developing a more efficient system and maintaining the integrity of the tax and social payments system. However, it guides our thoughts as how the system should evolve over the near term.

Implications for taxpayers

3.17 The impact of an increasingly digital business environment will differ by type of taxpayer. Most individuals receive income with PAYE deducted and investment income with tax already withheld. Third parties (employers and financial institutions) supply this data to Inland Revenue and this pre-populates taxpayers’ income tax returns. This flow of information is largely automated and imposes low compliance costs on taxpayers. The scope for improvement is likely to be limited, though there may be digital innovations to improve outcomes for some sub-groups such as individuals who receive social policy payments or who have debt to Inland Revenue.

3.18 However, it’s a different story for other types of taxpayers. Compared with individuals who earn wages from which PAYE is deducted, the self-employed, micro and small business segments tend to have more complex tax arrangements. Typically, they have been a harder group for Inland Revenue to serve. Evidence suggests they face high compliance costs relative to the tax they pay and may not be as compliant with their tax obligations.[9]

3.19 Larger businesses have complex and bespoke tax affairs that make them less receptive to the types of standardised solutions anticipated for smaller companies. However, there are still opportunities to improve how administration of the tax system works for them, for instance around minimising the compliance costs for the data they supply and how they supply it.

Inland Revenue’s role

3.20 The ideas discussed above are consistent with Inland Revenue’s business transformation. The potential policy and legislative changes discussed in this paper complement the technological capability arising from business transformation.

3.21 A more digital future will involve further change. Inland Revenue’s digital transformation has strengthened its ability to deliver services based on core information, involving collection and payment of money and processing at scale. More tailored services, which increasingly the public expects in the digital environment, are likely to come from private sector entities. For example, integrating financial management with tax management for a small business or providing budgeting assistance for someone with debt. Digital channels provide the opportunity for private sector entities to deliver customised services that can more effectively and efficiently meet taxpayers’ needs. The impact of these developments is that for these taxpayers Inland Revenue will act more as an enabler and the customer-facing parts of tax compliance would be delivered by private sector entities.

3.22 These shifts are motivated by making routine tasks, including tax, easier for customers. This produces lower compliance costs. It will also bring compliance benefits for the tax system. Where calculation and payment of tax is automated, compliance is improved because non-compliance requires more effort. Basic, unintentional errors are removed from the system. Digital transactions leave a footprint so make non-compliance riskier, and when business operations are fully digitised it’s harder to push transactions into a non-digital space. These developments mean we think a more digital and automated tax system will make it more likely that everyone is paying the tax they should, resulting in higher overall tax revenues for given tax settings.

3.23 Inland Revenue will evolve as a digital entity just as other businesses are doing. In a more digital world, issues like data security become even more important. Operating models will also need to adapt to take advantage of the technology Inland Revenue’s business transformation has delivered. For instance, a different approach may be needed for onboarding new users of gateway services than has traditionally applied to Inland Revenue accepting a new tax agent into the tax system. Where external parties have the primary relationship with the taxpayer, Inland Revenue’s relationship with those external parties will need to focus on how the system works overall.

3.24 New business models, for instance greater use of crypto assets, and new ways for taxpayers to meet their obligations will present risks as well as opportunities. An advantage that Inland Revenue has is its membership of international bodies such as the OECD, which enables New Zealand to participate in global solutions to challenges such as the taxation of multinationals. Within New Zealand, Inland Revenue will also need to participate with the private sector in the development of new business models to ensure the tax base is protected.

Digital inclusion

3.25 A more digital world works well for those able to embrace those technologies but can create barriers for those not able or wanting to participate in this way. Digital exclusion will arise for those lacking access to digital services and devices, skills in using them, and motivation and trust to operate in digital channels. The Government estimates one in five people lack at least one of the elements to be digitally included.[10] Groups who are less likely to be digitally included in New Zealand are: people living in social housing, individuals with disabilities, Pasifika, Māori, people living in large country towns, older members of society, and those not in the workforce.

3.26 However, people will use digital services if the benefit is clear and there are signs that innovative firms are finding ways to provide services catering for the digitally excluded. This will help bridge the barriers to accessing digital services. But these are at a fledgling state and at best will contribute to a solution rather than being the solution. Inland Revenue will continue to provide personalised services using non digital channels, such as phone and over the counter. Though these channels can appear more costly for service delivery, this has to be set against the right to access government services.

3.27 In contrast, we think professional parties have the capability to operate digitally and consequently there is an expectation that these groups should use digital channels to interact with Inland Revenue.

3.28 A related aspect of the digital story is expectations around small businesses adopting digital accounting software or using tax agents. Uptake of digital software amongst small businesses is increasing as businesses look for efficiencies and find more tailored services. However, options for business taxpayers to self-serve in less digital ways will remain.

How the shift to digital shapes this document

3.29 We have grouped the impacts from more digital processes into three areas – though noting a significant degree of overlap amongst them. These are:

• External parties: Their potential to meet the needs of taxpayers and recipients of payments and what changes are necessary to facilitate this.
• Data: Rationalising data collection and unlocking value through taxpayers authorising Inland Revenue to share their data.
• Tax rule changes: Adapting the tax system to more digital processes and making changes that facilitate a more automated approach to determining tax obligations.

3.30 Our exploration of these topics is covered in the next three chapters.