The New Zealand Tax Podcast More from the IRS on trusts and tax misalignment, BEPS, climate change
When I discussed the new tax bill last week, which includes the proposal to raise the income tax rate for trusts to 39%, I mentioned that Example 20 in the accompanying commentary had raised a number of concerns among tax advisers and tax advisors. It seemed to endorse trusts’ option to distribute income to beneficiaries with lower tax rates, which left us all wondering: is that really correct?
It turns out that the Tax and Customs Administration picked up on those concerns and then issued the following statement.
“We are also aware that one of the examples used in the Bill commentary and factsheet has caused some confusion. The example noted that trustees could distribute income to a beneficiary, who could then decide to reinstate it on the trust. We agree that there is some uncertainty under existing law regarding the tax treatment of such a settlement and we will be discussing it. To avoid that doubt, we have adjusted the example in those documents.”
The accompanying commentary has been updated and re-released. This shows that the area is not as cut and dried as people might imagine. Naturally, both the Tax and Customs Administration and the advisers want as much certainty as possible. It is therefore good that the Tax and Customs Administration is addressing this issue. But you wonder how it slipped into the commentary in the first place without anyone realizing it might be a problem.
Fixed misalignment issue? Not quite
Separately, another consultant (Aman Chand of Bentleys Chartered Accountants) picked up an interesting comment in the Regulatory Effect Statements (“RIAs”) issued alongside new legislation. RIAs discuss the purpose of this legislation, the alternative options and which one was chosen and why.
The problem that the increase in the tax rate for trustees to 39% addresses is one of a misalignment between the trustee’s income taxed at 33% and individual personal income taxed at a top rate of 39%. This issue was well understood at the time of the introduction of the reintroduction of the 39% tax rate in 2021. Inland Revenue and Treasury even said that the trustee rate should rise to 39% at the same time. And that’s what’s happening now.
But for some time now there has also been a rate discrepancy between the corporate tax rate of 28%, the portfolio investment entity (“PIE”) rate, which is also 28%, and the then highest individual personal rate of 33%. The IRS had been looking into this for some time and found that there was a steady accumulation of undistributed income in businesses. This rate misalignment issue was something that had been on its radar and it started taking steps to address it.
What Aman saw is that the RIA on the trustee rate increase addresses this existing misalignment issue. The RIA notes that ministers have decided to proceed with raising the tax rate for trustees to 39% “while taking into account longer term alignment issues between PIE and the company’s shareholders”. Even if the trustee tax rate is aligned with the highest personal income tax rate, there will still be opportunities to circumvent that rate by replacing trusts with corporations or PIEs. This is something that is going on, has clearly been on the radar of the IRS and will continue to be.
And even if there is a change of government after the October election that makes the top rate, 39% rate no longer applicable, the issue of a current rate variance between 28 and 33%, assuming that remains the top personal tax rate, remains. The Tax and Customs Administration is working on this and the RIA has some interesting details about possible options.
Don’t count on a change of government
Accordingly, people who hang their hats on a change of government to delay this particular issue of raising the trustee tax rate to 39% should still be aware that it is likely that the IRS will introduce other types of tax avoidance rules or recommend. to deal with fare variances in the future. The problem is on their radar, and it may still be something we will encounter regardless of who forms the post-election government.
Facebook, Google and BEPS
Last week I mentioned Facebook. New Zealand has released its results for the year ending December 31, 2022. And coincidentally, last week we also discussed the government’s proposals for the global anti-base erosion rules, the Pillar Two proposals which are designed to tackle the problem of base erosion and tackling profit shifting. (BEPS), where New Zealand’s tax base is being eroded by profits shifting from here to lower tax jurisdictions.
Facebook reported gross ad revenue of more than $154 million, but net profit before tax was $3.3 million. And that’s because over $149 million was paid to related company Meta Platform Ireland Ltd for the purchase of services during the year. Ireland’s corporate tax rate is 12.5%, compared to ours at 28%. Some of these payments may be subject to withholding tax if treated as royalties, but you still have an idea of the magnitude of the problem.
Coincidentally, last Friday after we recorded the podcast, Google New Zealand released its results for the year ending December 31, 2022. And in this case, it paid more than $870 million in service fees to offshore affiliates. Usually, it seems Singapore-based Google Asia Pacific Pte Ltd. You will not be surprised to learn that Singapore has a preferential tax regime. Incidentally, MasterCard and Visa New Zealand appear to be route their payments through Singapore.
To put everything into context about the magnitude of the problem we and other countries are facing, if you look at the 2022 results of Facebook and Google New Zealand, they paid over $1 billion in service fees to foreign affiliates for the year. In theory, at a 28% corporate tax rate, that represents more than $319 million in potential tax.
So the government and other governments would like to see Pillar Two and Pillar One hopefully come into play and address this issue of tax and profit shifting. But as the commentary on the bill that introduced Pillar Two legislation points out, the benefit is likely to be about $40 million a year.
The impact of the GloBE rules is therefore not very great. The problem of profit shifting remains. It will always be there anyway, as it is only appropriate that the tech companies charge for using their valuable IP in New Zealand. So it’s not a question of us not allowing $1.1 billion in deductions and bingo, we have $319 million. That’s never going to happen.
But the difficulty with transfer pricing really determines its value and how much of it can be held in New Zealand. And that will be an ongoing battle whether or not Pillar One and Pillar Two continue.
Please check
Finally this week the government announced that in the aftermath of Cyclone Gabrielle, 700 homes across the country are deemed unlivable.
And so homeowners are offered a voluntary surrender through a financing arrangement between the government and municipalities. Apparently another 10,000 homes will require investment in flood control around them so they can be protected when the next severe weather event hits. Notice the word “when”, I think we’re in the middle of climate change right now.
I mention this because it confirms the point we’ve been hammering on for some time. Climate change is here and it will affect homeowners across the country. It does not differentiate between suburbs. There is a good chance that in some cases we will have to think seriously about managed retreat, that more and more houses will be unlivable. The insurers are already pricing it in, so some homes may become uninsurable after a while.
The question that really comes to the fore now is who is going to pay for this buyout and managed retreat? For example, municipalities may have allowed properties to be built in areas where they should not have been built. Auckland Mayor Wayne Browne has already spoken about this. Incidentally, 400 of those 700 unlivable properties are in the Auckland region.
At a time when the Auckland Council budget for next year is going through a highly controversial process, having to somehow fund people from 400 properties at a time when the average house price in Auckland is $1,000,000 is a quite a blow to the even if the government intervenes.
This all reinforces what I’ve been saying for some time; the impact of climate change plus the demographic changes that are happening with the aging population means we really need to think much more carefully about how much tax we are going to need. Either that, or which services we’re going to reduce. And the issue of taxation of capital will become increasingly important. The politicians keep kicking it on the road, hoping it will just go away. It will not.
Climate change bills are now starting to come in and will continue to rise. We’ll wait and see which of the politicians in the main parties will grab that nettle and say, “Hey guys, this is the deal. If you want us to help you mitigate the impact of climate change, we need to spread the tax burden more widely.”
In the meantime I am Terry Baucher and you can find this podcast on my website www.baucher.tax or wherever you get your podcasts from. Thanks for listening and please send me your feedback and tell your friends and customers. Until next time, kia pai to rā. Have a nice day.
