While Minister of Revenue David Parker has said there will be “no new tax policy or tax switch” arising from the release of the report, he said it “will provide a fundamental baseline for debate” on the tax system.
The report, released on 26 April, brings into focus the importance of defining ‘income’ when assessing a person’s ETR.
Background
The beginnings of the report can be traced back to 2020, when the Government expanded Inland Revenue’s information gathering powers for tax policy development. The Government allocated $5 million in its 2021 budget to allow Inland Revenue to exercise its new power to conduct the research into ETR’s for high-wealth families in New Zealand.
Economic income
The report calculates the ETR for 311 high-wealth New Zealand families during the period 1 April 2015 to 31 March 2021. The calculation compares how much tax high-wealth families in New Zealand pay relative to their ’economic income’.
Economic income is a concept that is defined in the report to be an individual’s ability to consume goods or services which includes both taxable and non-taxable sources of income. Economic income seeks to measure the increase in an individual’s economic resources during the period and includes realised and unrealised capital gains.
Key findings
High-net worth individuals are more likely to hold capital assets than other taxpayers, whether directly or indirectly. Defining the comparator as economic income (wider than what is currently taxed in New Zealand), the report concludes that the main source of untaxed ‘income’ is realised and unrealised capital gains. Around 80% of the median high-wealth New Zealand family’s economic income was said to comprise realised and unrealised capital gains. The report makes the following specific claim:
Failing to tax forms of income that are earned predominantly by those who are better off is likely to have an important impact in reducing the progressivity of the tax system and is also likely to impose other economic costs through influencing the pattern of investment in the economy.
As a comparator to ETR’s based on economic income, the report also calculates an ETR based on a high-wealth New Zealand family’s ‘personal taxable income’. The report defines personal taxable income as income that is subject to tax under current law such as salary and wages, dividends and interest. The report concludes that the median personal taxable income ETR was around 30% on a median taxable income for a high-wealth New Zealand family. The report makes the following claim in this regard:
This result shows that taxes on personal taxable income are progressive and that high-wealth families will generally have a relatively high ETR on personal taxable income.
The report also identifies that 67% of the median high-wealth New Zealand family’s economic income was earned through trusts either as trustee income or capital gains from trust assets. The current tax rate for trustee income is 33%.
Implications
Tax policy and reform may be the subject of increased discussion in light of the release of the report, especially given 2023 is an election year.
While Minister of Revenue David Parker announced that there would be “no new tax policy or tax switch” arising from the release of the report, he noted that the report “will provide a fundamental baseline for debate on the fairness of our tax system, allowing future tax policy to be based on better data and more solid evidence”.
The report brings into focus the importance of defining ‘income’ when assessing a person’s ETR and the debate about what ought and ought not to be regarded as ‘income’.
The finding of a median 30% ETR on a high-wealth New Zealand family’s personal taxable income largely correlates with New Zealand’s progressive income tax rates. This suggests that high-wealth New Zealand families are paying the required amount of income tax on ’income’ that is currently subject to tax in New Zealand.
The finding of a median ETR of 8.9% on economic income reflects the adoption of a broader base for calculating the ETR. Use of economic income as a base is significant departure from the concept of taxable income under the Income Tax Act 2007, which does not include gains of a capital nature (subject to some exceptions, such as the bright-line test, the financial arrangements rules and the foreign investment fund rules).
The inclusion of unrealised capital gains within the income base is of particular note, as such ‘gains on paper’ may not indeed ultimately materialise. Many taxpayers would not regard an unrealised increase in the value of their home or their business as having the same character as other accepted forms of income, such as salary, dividends and interest. As far as we are aware, no jurisdiction imposes tax comprehensively on economic income as defined in the report. The last year also demonstrates that economic losses can be suffered by holders of capital.
The report only considers the position of the in scope high-wealth families. Any broadening of the tax base to include items of economic income would impact all holders of capital assets such as land and business assets, not just high-net worth families.
If you have any questions about the report and its potential implications, please get in touch with the contacts listed or your usual Bell Gully adviser.