Tax Tips. April In this issue: pwc.co.nz. New tax legislation enacted. The Tax Working Group is seeking comments on the future of the tax system

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1 pwc.co.nz Tax Tips April 2018 In this issue: New tax legislation enacted The Tax Working Group is seeking comments on the future of the tax system Ring-fencing rental losses: Officials issues paper

2 New tax legislation enacted The Taxation (Annual Rates for , Employment and Investment Income, and Remedial Matters) Act (the Act) received the Royal assent on 29 March Key changes in the Act include the taxation of employee share schemes, the reporting of employment and investment income information, and the extension of the bright-line test for residential properties. The Act incorporates a number of recommendations from the Finance and Expenditure Select Committee (FEC) following the submissions process. We discuss the changes in more detail below. Employee share schemes Chris Place Steve Camage Deesha Karve Key changes The Act introduces new rules for determining the amount and time of derivation of income and incurring of expenditure under an employee share scheme (ESS). The purpose of the changes is to effect tax neutral treatment of ESS benefits relative to cash-based schemes i.e. the tax position of the employer and employee should be as similar as possible whether remuneration is provided by either cash or shares. The new definition of employee share scheme means that the new rules apply to share benefits provided to employees (past, present, and future) as well as shareholderemployees. The FEC s report shows there were mixed submissions on the proposals, but the Act is substantially the same as the initial Bill - please refer to our April 2017 Tax Tips Alert for a summary of the proposed changes. In summary, companies should now be evaluating the impact of these rules on existing and future ESS on a holistic basis, and assessing whether their current approach is the most efficient and effective way of achieving the companies commercial objectives for implementing an ESS. Transitional provisions With some exceptions, the key aspect of the new rules (i.e. the shift to a deferred share scheme taxing date approach to taxing of ESS) will generally apply six months after legislative enactment, which allows employers a reasonable period, now finally locked in as the legislation has been enacted, to consider an appropriate approach under new law. Grand-parenting provisions will apply to ensure existing law continues to apply to share grants made prior to a date six months after enactment of the new law. The grant or acquisition date of the shares is the key determinant of grand parenting, which will apply to shares that were: granted or acquired prior to 12 May 2016 (the date of the Inland Revenue issues paper), or granted or acquired within six months of legislative enactment, where the taxing point under the new law arises prior to 1 April For exempt schemes (discussed further below), the changes will apply from the date of legislative enactment. 2

3 Impact for employees The key aspect of the Act is the introduction of the term share scheme taxing date, which will be the taxing point for all ESS once the new law is effective. The effect of this change is that the taxing point for ESS will no longer be the date on which the shares are acquired, but will shift to the point in time when the employee holds the shares on the same basis as any other shareholder, defined as the date on which: there is no material risk that beneficial ownership of the shares will change, and the employee is no longer entitled to be compensated for a fall in value of the shares, and there is no material risk that there will be a change in the terms of the shares affecting their value. The effect of the above changes will be to tax most ESS at vesting / delivery of unconditional ownership of the shares to the employees, based on the difference between what the employee pays for the shares and the value of the shares at that point in time (i.e. all ESS will be taxed on the same basis as options). The Commissioner is expected to issue guidance shortly as to how she will interpret the share scheme taxing date and the concept of material risk. Corporate tax deductions Another key aspect of the Act is the alignment of a corporate tax deduction to the taxable income that the employees receive under an employee share scheme. This change will not only: impact the amount of corporate tax deductions that can be claimed by employers, but also impact the calculation of tax balances for financial reporting purposes. As a result of this aspect of the changes, employers will be entitled to a tax deduction equal to the taxable benefit derived by the employee. A corporate tax deduction may in many cases be available even where no actual or real cost is incurred. However, employers will be denied a deduction for costs actually incurred in relation to the scheme, other than scheme administrative or management costs (e.g. group recharges will no longer be tax deductible). For tax exempt share schemes under section DC 12 of the Income Tax Act 2007 (see further below), a corporate tax deduction (other than scheme administrative or management costs) will not be allowed (effective from the enactment date of 29 March 2018). The change to the corporate deductibility rules will mean that many employers will need to re-evaluate their existing employee share schemes as they may no longer be as tax efficient as they previously were or, quite possibly, employers will be entitled to deductions to which they were previously not entitled. Accounting and impact on deferred tax The changes may also have accounting and tax accounting implications, particularly around the calculation of deferred tax. For entities reporting in accordance with NZ IFRS, a deductible temporary difference will arise between the tax base of the employee services received to date, and its carrying amount (if any) on the balance sheet. This difference will give rise to a deferred tax asset. Since the amount of the tax deduction to be obtained in the future is not known, management needs to estimate this based on the entity s share price at balance date. Financial statements prepared in accordance with NZ IFRS will need to reflect the impact of these new rules from 28 March 2018 (the date the Bill was considered substantively enacted). Those responsible for the tax accounting, particularly for entities with March reporting dates, will need to act quickly. This means understanding as soon as possible how the grand-parenting rules will apply to existing schemes, what amounts are likely to be deductible under the new rules, and confirming that the correct methodology is being used to calculate deferred tax and tax expense in profit or loss and/or equity. There are also practical points to consider, such as whether the information needed to prepare the deferred tax calculation is available, particularly where it has not been necessary to calculate deferred tax in the past. The calculation should be prepared on a tranche-by-tranche basis, and an assessment of the number of shares expected to be taxed at the share scheme taxing date in each tranche may be required. This would include considering the vesting conditions and the likelihood these will be met. In addition, the share price as at balance date will be required, which can be problematic where the shares are not listed. If tax withholding is to be adopted it is also important to consider the accounting implications of the approach taken under NZ IFRS 2 and in particular whether this results in the scheme being partially cash settled. 3

4 Impact on available subscribed capital The Act largely preserves the proposals for the creation of available subscribed capital for the employer, even where the employer is not the issuer of the shares. The creation of available subscribed capital for a corporate taxpayer that does not issue the shares is a tax concept that will create misalignment between available subscribed capital and actual paid up capital within a group of companies. The monitoring of available subscribed capital will create additional administration for taxpayers. Again, the Commissioner is expected to shortly issue guidance on this issue. Exempt schemes The Act introduces a simplified regime for exempt schemes, with increased and more generous share thresholds. Below are some of the practical features of exempt schemes that have been modified, making them more attractive and user friendly to employers: existing DC 12 tax exempt schemes should continue to satisfy the new requirements so there is no need to abandon or revise schemes that have already been approved under current rules (although companies may choose to do so as the new regime will be more generous) the discontinuation of the requirement for Inland Revenue approval, with a shift to schemes requiring registration with Inland Revenue only the absence of grand-parenting, which means new laws for exempt schemes can be adopted upon enactment of the law (with no six month delay to the new rules becoming effective) the removal of the requirement for a trust to hold the shares during the restrictive period (but no requirement to do so). In summary, the revised requirements provide further flexibility to employers in structuring exempt schemes. Our comments The new rules will completely change the way many employee share schemes are taxed and will have implications beyond just tax. Given the long term nature of most employee share schemes, and the relatively short timeframe before all employee share schemes become subject to these rules, it is important to now consider if and how the new law impacts current and proposed employee share schemes. This needs to be considered holistically. In particular, the impact of these changes should be considered in the context of: remuneration design and scheme objectives cash cost to company and employees and whether withholding will be utilised accounting consequences and deferred tax, and economic impact on employees, in particular relative to historic schemes. Get in touch with your adviser For further information, get in touch with your client services team or one of our specialists who can advise you on the tax and broader issues: Chris Place Steve Camage Deesha Karve

5 Reporting of employment and investment income information The Act introduces changes that are part of Inland Revenue s PAYE transformation project aimed at making tax simpler. The changes relating to employee and investment income intend to facilitate more efficient and timely provision of information to Inland Revenue. The changes represent a significant change in payroll reporting and will affect all employers. The rules can be voluntarily applied from 1 April 2018 and will become compulsory from 1 April Phil Fisher Josie Goddard Employment information Key changes include: Pay day reporting a key change in the PAYE reforms is the change to Inland Revenue receiving employment income information on payday rather than the current aggregated (monthly) basis. Employers in the default online group category will be required to provide payroll information to Inland Revenue in electronic form, within two working days of each payday. Various special case matters were raised in submissions. Some of the key recommendations adopted in the Act include: Out-of-cycle pays employers are now provided with the ability to report out of cycle pay with the next regular payment of salary and wages Schedular payments employers now have the option of reporting schedular payments twice monthly rather than each time a payment is made Employee share scheme benefits reporting frequency has been limited to twice monthly, and Reporting by non-resident employers operating shadow payrolls extra time has been allowed for reporting to Inland Revenue by non-resident employers operating shadow payrolls. Payment dates payment dates remain unchanged despite the change to payday reporting and employers may choose to pay PAYE and related deductions to Inland Revenue on a payday basis, or maintain the current once or twice monthly payments. Employee information changes encourage real time sharing of employee information by the employer intended to enable Inland Revenue to mitigate errors such as incorrect tax code use or incorrect deductions occurring. Payroll subsidies the payroll subsidy will remain for two more years, but will only be available to a narrower group of employers. There were a number of submissions opposed to the proposed repeal of the payroll subsidy, which suggested it should be better targeted or revisited once the other recommended changes had taken effect. The FEC report notes that as the subsidy only subsidises one model of payroll service it potentially distorts the payroll service and product market. However, Officials noted they would consider submissions further. It has been recommended that the subsidy is repealed completely in These changes will affect all employers and, as such, employers should be aware of the changes and the impact they will have on their business. Inland Revenue has been doing its best to reach a wide range of employers advising them of the changes before go-live and helping them prepare but they have not been able to reach everyone. Those responsible for payroll should be in discussions with the payroll provider to ensure that the payroll system will be compliant come go-live and plans should be made as to when your business will adopt pay-day filing. 5

6 Investment information The Act includes changes to improve the administration of investment income information, in particular relating to interest, dividends, royalties, PIE income, and taxable Māori authority distributions. The aim of the changes is to reduce compliance costs for recipients and administrative costs for the Government. Key changes relate to improving the frequency and level of information in relation to distributions, increasing electronic filing, and improving the administration of RWT exempt status. Submissions on the Bill were generally supportive of the proposed changes. However, there was concern that some of the proposals were overreaching and would result in unnecessary compliance. As a result of submissions, the following amendments have been made to the Act: Removal of the requirement that payers report detailed information on payments made to payees with RWT-exempt status and removal of the requirement for taxpayers with RWT-exempt status to provide detailed information in relation to the acquisition or disposal of financial arrangements. Removal of the requirement for PIEs to report investors prescribed investor rates six-monthly. Reduction of the information reporting requirements for information that has not been digitised. Extension of the error correction provisions to PIEs and non-cash dividends. Removal of the requirement to provide company dividend statements and Māori authority distribution statements. Rather, the additional material in the statements that is not covered by the proposed monthly reporting will be added to the monthly reporting requirements. Amendment of the requirement to withhold RWT and provide information only to apply to a payer who makes interest payments of more than $5,000 a year. Extension of the brightline test in respect of residential property The Government released a Supplementary Order Paper (SOP) in February 2018 which has been included as part of the resulting Act. As a result of the SOP, the Act extends the bright-line test for residential properties from two years to five years. The new five-year rule will apply to residential properties that are purchased from the Act s date of enactment (29 March 2018). The extension of the bright-line test was part of the Government s election policy, therefore the change is not unexpected. The Government s view is that the extension of the rule will ensure property speculators pay tax on their gains and make property speculation less attractive thereby improving housing affordability for owner-occupied housing. 6

7 The Tax Working Group is seeking comments on the future of the tax system The Tax Working Group (the Group) was established in November 2017 as part of the Labour-led Government s 100-day plan. The Group has a broad mandate to consider options to improve the structure, fairness, and balance of the tax system. The Hon Sir Michael Cullen chairs the Group and the Group s members include representatives from the tax, finance, and business communities as well as representing Māori and sustainability perspectives. Sandy Lau Elizabeth Elvy While the Group has a broad mandate, the following areas are being contemplated specifically: the economic environment over the next five to ten years and the drivers of change in that environment whether taxing capital gains, land, or other housing tax measures would improve the tax system the possibility of a progressive company tax system, and the role tax has in delivering positive environmental and ecological outcomes. The establishment of the Group provides an opportunity for all of New Zealand to help shape the future of New Zealand s tax system. To this end, the Group released a submissions background paper, Future of Tax (the paper). The paper seeks feedback from the public on a broad range of issues that the Group considers important when examining any potential changes to New Zealand s overall tax system. The paper is an excellent commentary on the key issues that New Zealand should be thinking about when considering the future of its tax system. Specifically, it outlines the impending challenges, opportunities, and risks faced by New Zealand and the purposes and principles of a good tax system. It also provides an overview of our current tax system and the results arising from it. The paper encourages submitters to think outside the current settings, to consider inconsistences in the current system, and whether there is a case for the introduction of new taxes. The Group is likely to issue its final report to the Minister of Finance and the Minister of Revenue in February An interim report covering proposals is expected in September 2018 to allow for further public consultation. Brittany Stewart 7

8 We discuss below some of the key aspects covered in the paper. New Zealand s current tax system New Zealand currently has a broad-base, low-rate (BBLR) tax system allowing the Government to raise substantial revenue with relatively low rates of taxation. The paper notes that the Government raises about 90% of its tax revenue from individual income tax, goods and services tax (GST), and company income tax. These taxes have very few exemptions. New Zealand s GST system is particularly well regarded internationally as being simple and comprehensive. GST is imposed at a low rate and allows very few exemptions. The notable exception to the current BBLR framework is the lack of a comprehensive capital gains tax, which is something that the Group is considering specifically. Another unique feature of New Zealand s current tax system is that it does not generally seek to deliberately encourage taxpayers to modify their behaviour (with the notable exceptions of alcohol and tobacco taxes). The paper also notes other key results of New Zealand s current tax system, including: Higher-income households play an important role as the share of all income tax paid increases as household income increases. The tax and transfer system reduces income inequality. There is continued debate on the influence of current tax settings on the rate and composition of saving. Ideally, a BBLR tax system should not create different tax outcomes between types of investment. Addressing change Another key theme of the paper is the acknowledgement of the rapid changes facing New Zealand and the rest of the world. While the New Zealand tax system has many strengths, given the rate of change, it is important that our tax system continues to evolve alongside the ongoing changes to business, technology, and society. Within this context, the Group has identified the following eight areas that, in its view, will continue to have an impact on New Zealand s tax system in the future: Changing demographics, such as the aging population and fiscal pressures As a result of New Zealand s aging population, it is projected that by 2036 around one in four and a half New Zealanders will be aged 65 or higher. This means a smaller working population will support a larger number of retirees. The Group is considering how the tax system should change to cope with these pressures. Te au Māori and the future Māori economic development is identified as a key driver in improving the living standards of New Zealand. The paper calls for submissions from Māori on the Māori economy and how the tax system can support this growth. The changing nature of work There is a global trend of workers embracing the gig economy, which has the ability to severely impact New Zealand. Individuals working in this area of the economy are likely to have less regularity in their sources of income, working hours, and conditions. This change in the nature of work could decrease the amount of PAYE taxation the Government derives as the PAYE system is very much built towards regularity of work. This is a concern as PAYE currently represents almost half of all taxation revenue collected. Technological change Online platforms have introduced new ways for people to earn income beyond a standard salary or wage, such as blockchain technologies, the short-term rental of homes, and ridesharing. Artificial intelligence and robotics have the potential to replace tasks currently undertaken by humans, potentially reducing the amount of tax revenue collected through PAYE. With the current pace of technological advancements, the Group wants to consider how the tax system will remain robust but flexible in its ability to collect revenue under these new business models. Company tax pressures New Zealand has a relatively high headline company tax rate by OECD standards. However, the operation of the imputation system generally lowers the effective tax rate for domestic shareholders (as they are effectively taxed at their marginal tax rates) but this does not apply for foreign investors. There is a question as to whether the current company tax rate impedes on New Zealand s competitiveness. However, the Group recognises that this needs to be balanced with the general cohesiveness with personal tax rates. An increase in the disparity of the tax rates can lead to tax sheltering arrangements. The Group notes this is an issue that should be considered if a decision is made to reduce the company tax rate in the future. Environmental challenges Climate change represents a significant global challenge for people, the environment, and the economy. New Zealand is particularly vulnerable because of the importance of the ecosystem e.g. agriculture, fisheries, and tourism industries. The paper seeks wide submissions on the opportunities for effective environmental taxation. Concern about inequality Public concern regarding wealth and income inequality is rising. The progressivity of taxes, the overall level of taxation, and the mix of taxes all affect inequality. The paper asks how taxation could better address the issue of inequality in New Zealand. Changing patterns of globalisation Globalisation has allowed increased access to a multitude of goods, services, and markets. This has also caused a reduction in local production and a subsequent loss of jobs. From a tax perspective, the shifting of economic activity reduces New Zealand s ability to tax persons under a system that relies on a person s physical presence, so the paper requests submissions on any issues that New Zealand should particularly focus on. 8

9 Principles of a good tax system The Group is taking a holistic view of the role of the tax system, taking a broad range of principles into consideration when assessing the performance of the current tax system as well as any potential changes. Fundamental principles include equity, certainty, fairness, and integrity. Further, the Group is also turning to the Treasury s Living Standards Framework to assist with assessing the impact of taxes and wellbeing. The framework outlines four pillars of capital: natural capital (the natural environment) human capital (people s skills, knowledge, physical, and mental health) social capital (norms and values that underpin society), and financial/physical capital (the country s physical and financial assets). Use of this framework is recognition that the Group is focused on interconnected dynamics and trade-offs that result from the tax system on all measures of wellbeing. This approach also aligns with the Government s wider public policy direction. Specific challenges being considered by the Group In addition to the eight broad areas of change for consideration outlined above, the Government has requested the Group to advise on some specific challenges. The Group is seeking public submissions on all of these challenges: Capital gains tax or land tax - how these taxes would affect housing affordability and if they would improve the current system for capital income taxation. The paper includes an appendix outlining specific questions to submitters on the design issues with a capital gains tax. Progressive company tax the Group is considering whether there is a case to introduce lower company tax rates for smaller businesses in order to better support small business. Environmental taxation whether there is a case to use taxation to improve environmental outcomes. GST exemptions whether low-income people could be assisted by providing GST exemptions on certain goods and services. Our comments We welcome a review of the current tax system. The current Tax Working Group is an exciting opportunity for all of New Zealand to challenge the current thinking about our tax system and help shape what our future tax system may look like. Although it was only eight years ago that the previous Tax Working Group released its final report, with the most notable change from the Group s recommendations being an increase in the rate of GST, the reality is that a lot has changed in that short period of time. Therefore, it is a good time to re-examine our tax settings. In our view, New Zealand should continue to revisit those settings to ensure our tax system keeps pace with our rapidly changing environment. Finally, we also see that the current Tax Working Group has a much stronger emphasis on engaging with the wider public in understanding their views and interactions with the tax system when compared to the previous Tax Working Group. Specifically, the Group is encouraging all New Zealanders to share their views about the current tax system, with a particular request for Māori to submit on any part of the tax system that warrants review from the point of view of te ao Māori. Submissions are due on 30 April and comments are sought on the questions outlined in the paper by the Group as well as any other issues raised by submitters that are not excluded by the Group s terms of reference. 9

10 Ring-fencing rental losses: Officials issues paper Last month, Officials released an issues paper about the ring-fencing of rental losses. The proposal to ring-fence rental losses is part of the Government s measures to increase housing affordability for owner-occupiers and means that investors will no longer be able to offset tax losses from residential property against other income. The proposed changes aim to reduce the benefits that property investors currently have over home buyers, mainly that investors can in part subsidise their mortgages on investment properties by reduced tax on their other income sources. The changes will operate to ring-fence losses generated by investment properties so they cannot be offset against other income, but can be carried forward and offset when the properties are making profits or if a taxable gain arises on sale. The paper suggests the rules apply on a portfolio basis, rather than property-by-property, so an investor with multiple properties could calculate an overall profit or loss across their residential portfolio. The loss ring-fencing rules will apply to residential land as currently defined for the purposes of the bright-line test for residential property sales. Therefore, the rules will not apply to: a person s main home a property that is subject to the mixeduse asset rules, or land that is held on revenue account. Under the proposed changes, special rules will be introduced to ensure that entities such as trusts, companies, partnerships, and look-through companies cannot be used to circumvent the ring-fencing rules. Application date for the new rules will be the income year. However, Officials are still considering whether the rules will be applied in full from the application date or a phased approach taken. Submissions have been requested on this point. Submissions on the proposals are due by 11 May Please get in touch with your usual adviser if you would like to discuss the proposed changes in more detail. Submissions on the proposals are due by 11 May Please get in touch with your usual adviser if you would like to discuss the proposed changes in more detail. 10

11 Upskill with us Accounting and taxation Training for today s business issues and tomorrow s challenges. Register today for our upcoming courses. Tax insights webinar series Webinar 18 April The tax world is constantly evolving. Our monthly one-hour webinar updates are a perfect way to stay on top of changes which will impact on you, your clients and your employer. Indirect tax PAYE and WHT Auckland 1 May, Wellington 3 May, Webinar 4 May This session focusses on pay as you earn (PAYE) and withholding tax (WHT) matters and the taxation of allowances. Indirect tax FBT Auckland 10 May, Wellington 17 May, Webinar 18 May This session focusses on fringe benefit tax (FBT) compliance. Taxation of investments Auckland 15 May, Webinar 17 May Investment tax experts will use practical case studies in a question and answer format to highlight key issues in relation to the taxation of investment income. Accounting for non-accountants Auckland 9 May, Wellington 16 May This one-day workshop will help you understand the language of accountants, key concepts and the information presented in financial information. Tax effect accounting Auckland 6 June, Christchurch 20 June This half-day seminar combines case studies and presentations to cover the practical challenges of preparing year-end tax accounting calculations and financial statement disclosures. You can find out more information about each of our courses and register online at training.pwc.co.nz 11

12 Contributors Chris Place Partner T: E: chris.g.place@nz.pwc.com Sandy Lau Director T: E: sandy.m.lau@nz.pwc.com Lyndsay Taylor Director T: E: lyndsay.m.taylor@nz.pwc.com Elizabeth Elvy Senior Manager T: E: elizabeth.a.elvy@nz.pwc.com Deesha Karve Manager T: E: deesha.x.karve@nz.pwc.com Phil Fisher Partner T: E: phil.j.fisher@nz.pwc.com Steve Camage Director T: E: steve.c.camage@nz.pwc.com Jane Exeter Senior Manager T: E: jane.x.exeter@nz.pwc.com Josie Goddard Manager T: E: josie.r.goddard@nz.pwc.com Jordan Yates Associate T: E: jordan.r.yates@nz.pwc.com Brittany Stewart Associate T: E: brittany.a.stewart@nz.pwc.com Connect with us Follow us on Visit us online at pwc.co.nz us tax@nz.pwc.com 2018 PricewaterhouseCoopers New Zealand. All rights reserved. refers to the New Zealand member firm, and may sometimes refer to the network. Each member firm is a separate legal entity. Please see for further details.