New Zealand Budget Report

May 2003

Prepared by the CCH Tax Editors, in association with

and

The Treasurer and Minister of Finance, the Hon Dr Michael Cullen, presented the 2003 Budget Statement to Parliament on 15 May 2003. This CCH Budget Report has been prepared with the assistance of specialist
practitioners from Ernst & Young and Bell Gully. It covers announcements of interest to tax practitioners and the business community.

Ernst & Young is one of New Zealand's leading professional services firms, offering clients a full range of services in taxation, assurance, corporate finance, real estate and business partnering. Ernst & Young has focused tax groups which provide specialist tax advice and assistance to the corporate and entrepreneurial sectors based on the strengths of both their local expertise and the support of the global Ernst & Young network.

Bell Gully is a leading New Zealand corporate law firm with extensive commercial, corporate, finance, banking, taxation, litigation and commercial property experience. Bell Gully's tax division is one of the largest corporate tax divisions in a New Zealand law firm and advises on all aspects of New Zealand taxation including a substantial tax litigation and indirect tax practice.

2003 Budget overview

The 2003 Budget indicates that the Government's finances are very healthy. For the current financial year the Government is projecting an operating balance of $4.04 billion. For the next financial year the operating balance is expected to fall to a still healthy $3.8 billion (followed by expected balances of $4.5 billion in 2005, $5.3 billion in 2006 and $6.2 billion in 2007). Perhaps it is fortunate that there is no sanction against the Government for over-taxation.

The Budget papers clearly suggest it is unlikely that this over-taxation will abate. Unfortunately there are too many risks such as drought, the rising dollar, SARS and diminishing Maui gas reserves. As a consequence the strong economic growth enjoyed by the country in recent times is expected to slow, at least in the near future.

This viewpoint raises the question of whether the times will ever be thought to be conducive to a reduction in the levels of taxation. It is of course easy to box at shadows but the reality of some of the alleged risks can be queried. Both drought and a strong dollar are unlikely to be permanent phenomena. It is also the case that an economy is never static. Unfavourable developments in one area can be balanced out by unexpected good fortune in another. There must come a point when a Government is persevering unnecessarily.

In this regard the recent Australian experience is instructive. The Federal Government found itself in a position of achieving an estimated surplus of $A3.4 billion for the 2003/04 year. The Government elected to forgo $A2.4 billion of the estimated surplus by making tax cuts of that amount. This development raises the question of whether the risks faced by New Zealand are truly any different from those faced by Australia.

Slow progress on superannuation savings

Ministerial statement

"The Government acknowledges that there are a number of disincentives to saving through employment-based schemes and for employers to offer these schemes.

Within the next few weeks, the Government will be introducing legislation to remove the current over-taxation of employers' contributions to superannuation funds on behalf of low-income savers. The present tax rate on employer contributions is a flat 33 per cent, regardless of income.

From 1 April next year, employers can apply a lower tax rate of 21 per cent on contributions made to superannuation funds on behalf of employees earning under $38,000 a year. This should remove one of the disincentives for low-income earners to save through employment-based schemes.

The direction of the Government's future work in this area is to look at removing the disincentives for employers to offer these schemes, and the inequity of the current tax law in overtaxing a fund's earnings in relation to low income savers.

The savings industry and the government are cooperating on this work which is moving in parallel with that being undertaken by the Periodic Review Group on retirement income policy."

Editorial comment

Adequate provision for retirement is an issue that has been extensively debated over the last 10 to 15 years. There have been numerous consultative committees and other governmental reviews. At this stage the only progress able to be reported is that from 1 April 2004 the rate of employer superannuation contribution withholding tax will reduce from 33% to 21% for employees who earn less than $38,000.

At the same time the Government has announced that its "future work" will be to look at the over-taxation of the earnings of a superannuation fund member whose annual income is below $38,000. Currently, those earnings are taxed at 33% in the hands of the superannuation fund. This compares unfavourably with a 19.5% tax rate that would be applicable if the earnings had been derived by the member directly. Presumably it is the business of the Periodic Review Group to advise on this topic.

The Government can be criticised for the slow pace of progress in this area. The first measure of a reduction in the withholding tax rate addresses so obvious a flaw in the existing regime that it should never have been enacted in the first place.

Similar criticism can be leveled at the second issue of over-taxation of fund earnings. Readers will recall that in 1998 measures to overcome the problem came close to enactment. The only development since then seems to have been further study of the problem.

The pace of change in development of a coherent tax model for superannuation stands in sharp contrast to the establishment of the New Zealand Superannuation Fund. Following announcement of introduction of the concept in 2001, legislation has been enacted and contributions made totalling $2.499 billion (with an additional contribution of $1.879 billion planned for the year to 30 June 2004). These contributions are currently projected to generate a net after-tax return to Government of 7% per annum. Developments on this front show that progress can be rapid if it needs to be.

No doubt it is possible to say that the issues in this area are complex and that they require time to work through in order to arrive at a coherent and enduring system. More cynical observers may view this kind of argument as designed to throw dust in the eyes. These commentators might be inclined to argue that the real reason for dilatory progress lies in the notion that Government gets comfortable in the tax revenues generated. The unquenchable thirst for taxation revenues leads to the enactment of a regime that goes too far. Future reform then becomes limited to changes at the margin.

Tax simplification continues to continue

Ministerial statement

"While international studies suggest compliance costs for business are lower in New Zealand than in most other developed countries there is still a lot that can be done...

In the course of development and due for release for discussion over the coming months are a number of more innovative measures to help small businesses...

The purpose of all these initiatives is to assist businesses to meet the responsibilities of living in a well-ordered and progressive society at minimal costs in terms of both time and money. It does need to be said, however, that some compliance costs are an intrinsic part of living in such a society."

Editorial comment

The Budget papers refer to existing or new initiatives primarily directed at small and medium-sized enterprises (SMEs). These include:

1. an SME Summit in February 2004 to outline assistance initiatives and highlight achievements and innovation;
   
   
2. a Small Business Advisory Group to advise Ministers and the Ministry of Economic Development;
   
   
3. tax pooling through commercial intermediaries;
   
   
4. alignment of provisional tax and GST payment dates;
   
   
5. basing provisional tax on a percentage of GST turnover;
   
   
6. subsidising employers. costs of engaging payroll firms (August discussion document to explain);
   
   
7. incentivising new businesses to pay provisional tax in the first year; and
   
   
8. simplifying the previously complicated FBT calculations and returns.

Goods and services tax

Ministerial statement

"The next tax bill will include a proposal to subject to GST some imported services and to remove multiple layers of GST that can be imposed on the financial sector."

Editorial comment

These measures alleviate the GST cost burden on the financial sector while imposing GST on certain imported services.

Tax rates

Ministerial statement

"As part of our overall judgements about the economic and fiscal outlook, we need to assess what proportion of the budget surplus is likely to be structural and what may be due to purely cyclical factors."

Editorial comment

The Budget papers contain no specific indications of any corporate or personal tax rate changes despite the forecast of increasing annual surpluses and reduced growth expectations. The papers suggest that next year's Budget is likely to contain measures to assist low- and middle-income families and the welfare-to-work transition. There is no comment on measures for other families, individuals, corporates or other entities.

This approach contrasts with Tuesday's Australian Budget which delivered significant income tax cuts by reducing the tax rate threshold levels for personal tax.

Migrants

Ministerial statement

".... the government will this year consider measures to provide a temporary exemption for migrants from tax on foreign income, the cost of which, in many cases, must now be paid by New Zealand businesses that require the skills of those migrants."

Editorial comment

The Minister is concerned New Zealand should not lag behind Australian initiatives in this regard.

The Australian Government remains committed to a four-year exemption for foreign-sourced income of new migrants, although this policy has yet to be passed by the Australian Parliament.

Triangular tax

Ministerial statement

"The next tax bill will include legislation to put into effect the agreement we have reached with the Australian government on trans-Tasman imputation."

Editorial comment

This refers to the "triangular tax" problem where Australian or New Zealand shareholders invest in a company in the other country but earn income in their own country.

The agreement provides for a limited pro rata apportioning (to local country shareholders only) of available local tax credits according to the respective Australian and New Zealand shareholder proportions.

In February, the Government announced that this agreement would be effective from 1 April 2003, with franked or imputed dividends able to be paid out after 30 September 2003.

Overseas venture capital investors

Ministerial statement

"A tax policy priority this year is to bring forward proposals to enable overseas venture capital to be invested in New Zealand in accordance with normal international tax rules."

Editorial comment

This is intended to ensure that New Zealand is not uncompetitive with Australia in this important area of investment. Australia has recently enacted a tax regime with significant advantages for qualifying entities over those applying in New Zealand. In New Zealand, consultation leading to specific proposals and legislation is expected to be undertaken later this year.

Research and development

Ministerial statement

"Early in our first term of government, legislation was enactedthat allowed a deduction for research and development expenditure that is reported as an expense for accounting purposes. A private sector group has been established to report to the government on how well this is working. It would not be surprising if this results in some modifications to the law to remove any identified problems."

Editorial comment

The comments are apparently a reference to the deduction incorporated in s DJ 9A of the Income Tax Act 1994. As enacted with effect from 1 April 2001, the section authorises a current year deduction for expenditure on research and development.

Seemingly the effectiveness of s DJ 9A is under review by "a private sector group". Previously little indication has been given of the work of this group, so the transparency of the process is not obvious.

The Budget comments indicate that any review is of a "fine-tuning" kind. This would seem to eliminate any possibility that the review will encompass the expansion of the deduction. Some commentators would argue that any deduction conferred should be greater than 100% of eligible research and development expenditure. In a fast changing and ever more technological world it is crucial that adequate funding is applied to research and development. These commentators would query whether a 100% deduction is adequate.

There would be little scope for optimism that the benefit of the deduction would be increased beyond 100%. The strategy of the Government seems to be that any State assistance in this area is to be through grants to approved applicants. The Government apparently rejects the model of enhanced deductions for enterprises that exercise their own business judgment and elect to invest in innovative propositions.

Evidence of this strategy is apparent from the Budget papers. The papers indicate that the Government plans to invest a total of $397 million in a "2003 Growth and Innovation package".

Some of this spending is of questionable quality. For example, the Budget papers advise that environmental research spending will increase by $4 million over four years with an additional $1 million per annum directed towards developing alternative possum control methods. No doubt a serious argument can be maintained that possum control is important for the future well-being of the nation. However, there must also be a question mark whether such an item is rightly part of a package of measures intended to achieve "sustainable economic growth and innovation".

Some readers may also question when and where the $397 million will actually go. These readers may have in mind the sums of upwards of $100 million that were extracted from Crown research institute businesses for investment in venture capital propositions. While a laudable objective, the application process has proved to be arduous with a consequent loss of momentum.

Wealth tax on offshore investment still considered

In the 2002 Budget the Minister of Finance indicated that he was still reviewing proposals concerning the wealth tax on offshore investment made by personal investors. The 2003 Budget papers indicate that these proposals are still under review.

Readers will recall that this proposal emanated from a recommendation in the McLeod Report of 2001. Broadly the concept was to impute a notional return on most assets apart from personal chattels and deem that return to be an item of taxable income. Although a wealth tax it was described as a "risk free rate of return" method of taxation, presumably to make it more palatable.

The ensuing outcry over the prospect that this would result in the taxation of the equity in personal housing led to a considerable contraction of the concept. The Government's proposal was that a notional return would be imputed to only the foreign equity investments of taxpayers not engaged in business. The 2002 Budget papers indicated a likely start date of 1 April 2004.

Evidently the Government is continuing to pursue this tax. As part of the summary of "unchanged risks" the 2003 Budget papers include the comment:

"The Government is considering the application of the Risk Free Return Method of taxation to equity investments on capital account or outside a business context. A number of details of the proposal need to be further developed and, if a decision to proceed is taken, the proposal will be subject to full consultation, so it is not expected to be implemented before the 2004/05 tax year."

These comments have flowed through to inclusion of an expected increase of $20 million to the Government's operating balance from 2004/05. On the other hand, the impact on Government funding of the changes to the taxation of superannuation (reported above) is described in the Budget papers as "unclear". Some readers may be left wondering whether there will be a happy coincidence between the projected $20 million annual revenue from the wealth tax and the loss of revenue from the reduction in the rate of specified superannuation contribution withholding tax.

More measures to combat tax avoidance

Ministerial statement

"The fundamental objective of our tax system remains the raising of revenue to meet our social and economic objectives. This needs a constant programme of measures to counter the ingenuity of those who will go to great lengths to avoid tax.

The next tax bill will include measures along these lines. One of these is aimed at schemes that are structured to offer high income investors a return from tax deductions to the extent that the investors need not be concerned with the underlying economics of the arrangement. Many of these base maintenance measures have been targeted at individual taxpayers. Large companies and the financial sector benefited from New Zealand.s strong economy over recent years. Budget 2003 provides Inland Revenue with the resources to apply the law, and proposes changes to the law if that is needed, to ensure that these high profits are being matched by tax payments."

Editorial comment

The remarks are not complemented by an outline of supporting details. Readers are left to conjecture what schemes the Minister has in mind and when the remedial legislation will become effective.

The tenor of the Minister's comments indicates that the measures will be aimed at schemes that employ limited recourse loan techniques. Such arrangements could lead an investor to be unconcerned about the economic implications of an investment proposition. Currently s DK 1 of the Income Tax Act 1994 overcomes the benefits of limited recourse funding in film investments. Presumably the proposed measures will see the expansion of s DK 1 beyond its specific context.

The Budget papers also give no indication of the dimensions of the problem. However, it is interesting to note that the Government's list of quantifiable contingent liabilities records a liability for tax in dispute of merely $40 million. The list of contingent liabilities records "the amount claimed" where legal action has been taken against the Crown. The amount shown is the maximum potential cost to the Crown. Unfortunately it is not possible to deduce any connection between the outstanding $40 million of tax in dispute and the possible fiscal cost of the structured investment schemes.

Carbon tax

The Budget papers note that the Government has approved a policy package to meet commitments under the now-ratified Kyoto Protocol. This package includes a carbon charge with negotiated greenhouse agreements for certain at-risk firms.

Foreign direct investment

The Budget notes that the Government is still deciding its position on the Tax Review 2001 recommendations concerning foreign direct investment. These included a headline company tax rate of 18%. Any new measures are not expected to apply before 2004/05.

Low income tax credit

Ministerial statement

"The income thresholds for Family Support, Child Tax Credit and Parental Tax Credit are to be increased, making this assistance available to more families."

Editorial comment

These new (unspecified) thresholds will be effective from 1 April 2004 and will cost $59 million over four years.

 

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