CORPORATE TAXPAYERS GROUP C/- Deloitte Attn: Mike Shaw P O Box 1990 WELLINGTON Telephone 04 495-3932 Facsimile 04 472-8023 Emissions Trading Scheme Tax Issues C/- Deputy Commissioner Policy Advice Division Inland Revenue Department PO Box 2198 WELLINGTON Dear Robin EMISSIONS TRADING TAX ISSUES The following submission has been prepared by the Corporate Taxpayers Group (the Group) on the Emissions Trading Tax Issues officials issues paper (the paper). This submission is concerned with the general tax issues that arise as a result of the proposed Emissions Trading Scheme (the Scheme) given they will likely have a material impact on New Zealand businesses. The Group will provide comments and suggestions on the design and administration of the Scheme to the relevant Select Committee once the Bill has been released. The Group s focus when making those comments will be to ensure that all aspects of the regime are appropriate, easily workable and result in low compliance costs, which is also the focus of this submission related to the tax aspects of the regime. Finally, this submission refers to New Zealand Units (NZUs), but all comments made in this submission are intended to apply equally to all international equivalents of NZUs as and to the extent to which these international equivalents are utilised under the New Zealand Scheme. SUMMARY The Group makes the following initial submission points and recommendations with respect to the paper. The Group s objective is that current tax principles apply to NZUs so as to not only ensure their tax treatment correlates with equivalent instruments but also to mitigate the need to legislate for separate regimes when minor additions to existing regimes may suffice. The Group is particularly looking for the tax treatment of NZUs to be as simple as possible to ensure that they do not result in high compliance costs to taxpayers.
Page 2 of 8 The general tax principles that should guide the taxation treatment of NZUs include the capital revenue boundary i.e. units allocated for capital items should not be taxable, whereas units allocated for revenue items should be taxable. Further, that any market value fluctuations should be deferred from a tax perspective until those gains have been realised. The Inland Revenue should specifically clarify the application of key provisions and regimes to NZUs, for example the interplay with the financial arrangement rules and whether, say, NZUs will be specifically included as an excepted financial arrangement. The Inland Revenue also needs to be ready to respond quickly to any tax issues that may arise from NZU related transactions that are not currently envisaged (given the emerging nature of NZUs and the developing manner in which market forces will respond to this business issue). The Group expects that such issues may arise as derivatives are developed to help businesses manage their obligations under this regime. Free units The Group believes that the tax treatment of the free allocation of units should remain flexible and should be based on normal tax principles. As the free NZUs are in effect compensation to the taxpayer, the treatment of the allocation should be determined with reference to the nature of compensation being provided. If the free NZU is allocated specifically to compensate increased revenue costs (for example, electricity) to the taxpayer then the NZU should be treated as revenue and taxable. If the free NZU is allocated to compensate the taxpayer for say a diminution of the value of the taxpayer s business / capital asset / structure (as a result of the implementation of the Scheme) then the free allocation should be classified as capital (including the subsequent gains or losses on the disposal of the free units). The Group notes that the paper is written on the assumption that the issue of free NZUs is for increased revenue costs. This will not be the case in all circumstances and as far as many taxpayers are concerned, the free units partially compensate them for a reduction in the value of their business / capital asset / structure. Where both capital and revenue components are present, appropriate apportionment methodologies should be available to taxpayers and accepted by the Inland Revenue. In terms of free NZUs that are issued to offset a direct NZU obligation of the taxpayer (i.e. the taxpayer has a liability of 1 NZU and therefore receives 1 free NZU), the result should always be a nil tax effect impact for that taxpayer. Specifically income and deemed deductions for the free NZU should be valued at nil to produce a nil result, or alternatively the free NZU should be treated as income at the same value and time as the obligation to surrender NZUs, again producing a nil result. In terms of free NZUs that are taxable, the NZUs should be taxable on an accrual basis and taxpayers should have flexibility on when they return this income, that is, the free NZU should be deemed to be derived based on an emerging basis that reflects their business. The Group believes that the method taxpayers adopt for financial reporting purposes should also be legislated as acceptable for tax purposes. The value attributed to free NZUs that are taxable should be viewed as derived under the taxpayers emerging basis and should not be the market value at year end. Rather it should be the market value at the time when the NZUs are issued to the taxpayer (i.e. the opening market value) or the market value at the time when the NZUs are treated as being derived (i.e. throughout the income year, namely an average market value).
Page 3 of 8 Given this, there is no need to separately value such free NZUs held at year end for tax purposes as there should be no mark to market type calculation done each year in relation to NZUs. Acquired NZUs to meet NZU obligations (i.e. which will be on revenue account) Such NZUs acquired by taxpayers during a year should be deductible when incurred. At year end, NZU s acquired by taxpayers that are not attributable to that years carbon obligations should be added back for tax purposes in accordance with EA 3 principles and deducted in the following year. Losses made on excess NZUs acquired during the year and still held at year end should be able to be taken into account in the year, equivalent to valuing trading stock on a lower of cost or market methodology. Accruals of NZU obligations (which will be on revenue account) At year end taxpayers that have not acquired sufficient NZUs to meet their obligations for that year can accrue for tax purposes an amount of estimated expenditure expected to be incurred to purchase NZUs to meet their obligations. The Group believes that the method taxpayers adopt for financial reporting purposes should also be legislated as acceptable for tax purposes. Deductibility of emission activities The Group considers that the standard tax deductibility analysis should provide for deductions for costs associated with emissions obligations, including any costs associated with the trading of NZU and any other charges imposed on emitters under the Scheme; however the Group is supportive of the introduction of a specific deductibility provision so as to ensure that there is absolute clarity on this point. Alternatively, the deductibility position should be clearly articulated in a Tax Information Bulletin. Other For GST purposes the supply of NZUs should be zero rated to reduce complexity when NZUs are traded. The Group believes that penalties imposed under the Scheme (as originally proposed) should be deductible where the taxpayer has unintentionally calculated their obligation incorrectly as the penalty has no regard to culpability there is no public policy grounds to negate a deduction being taken akin to other normal business expenditure. The Group does not provide any comment on the taxation of NZUs as they relate to forestry. DETAILED COMMENTS The Group provides detailed comments on general tax issues in Appendix One.
Page 4 of 8 CONCLUSION The Group thanks you for the opportunity to comment on the paper. For your information, the members of the Corporate Taxpayers Group are: 1. Air New Zealand Limited 2. AMP Life Limited 3. ANZ National Bank Limited 4. ASB Bank Limited 5. AXA New Zealand Limited 6. Bank of New Zealand 7. Contact Energy Limited 8. Fletcher Building Limited 9. Fonterra Cooperative Group Limited 10. General Electric 11. Goodman Fielder New Zealand Limited 12. The Hongkong and Shanghai Banking Corporation Limited (New Zealand branch) 13. IAG New Zealand Limited 14. Infratil Limited 15. Lion Nathan Limited 16. New Zealand Funds Management Limited 17. New Zealand Post Limited 18. New Zealand Exchange Limited 19. Rio Tinto Alcan (New Zealand) Limited 20. Shell New Zealand Limited 21. SKYCITY Entertainment Group Limited 22. Sky Network Television Limited 23. Telecom New Zealand Limited 24. Telstra Clear Limited 25. TOWER Limited 26. Toll New Zealand Limited 27. Turners and Growers Limited 28. Vector Limited 29. Vodafone New Zealand Limited 30. Westpac New Zealand Limited 31. ZESPRI International Limited We note that the views in this document are a reflection of the views of the Corporate Taxpayers Group and do not necessarily reflect the view of individual members. Yours sincerely John Payne For the Corporate Taxpayers Group
Page 5 of 8 APPENDIX ONE GENERAL TAX ISSUES Free allocation of NZUs The Group believes that the tax treatment of the free allocation of units should remain flexible and should be based on normal tax principles. As the free NZUs are in effect compensation to the taxpayer, the treatment of the allocation should be determined with reference to the nature of compensation being provided. If the free NZU is allocated specifically to compensate increased revenue costs (for example, electricity) to the taxpayer then the NZU should be treated as revenue. If the free NZU is allocated to compensate the taxpayer for say a diminution of the value of the taxpayer s business / capital asset / structure (as a result of the implementation of the Scheme) then the free allocation should be classified as capital (including the subsequent gains or losses on the disposal of the free units). The Group notes that the paper is written on the assumption that the issue of free NZUs is for increased revenue costs. This will not be the case in all circumstances and as far as many taxpayers are concerned, the free units partially compensate them for a reduction in the value of their business / capital asset / structure. To provide certainty to taxpayers the Group recommends that a provision be inserted into the Act to clarify when the receipt of free NZUs is income to the taxpayer. If the free allocation of NZUs is explicitly provided to taxpayers in relation to capital expenditure (e.g. for building new plant), this receipt should not be taxable income. It is an affair of capital and should not be taxed. To immediately tax these units will result in the taxpayer having an inappropriate timing disadvantage. In that case the value of the free NZUs should be offset against the depreciable base of the capital asset. Gains or losses on the subsequent sale of these units should also be outside the tax base. The following comments deal with situations where the free units are within the tax base, which is the assumption upon which the paper is drafted. By making these comments the Group does not wish to detract from the general view of many taxpayers that the free units partially compensate them for a reduction in the value of their business / capital asset / structure, and as such are an affair of capital. In terms of free NZUs that are issued to offset a direct NZU obligation of the taxpayer (i.e. the taxpayer has a liability of 1 NZU and therefore receives 1 free NZU), the result should always be a nil tax effect impact for that taxpayer. Specifically income and deemed deductions for the free NZU should be valued at nil to produce a nil result, or alternatively the free NZU should be treated as income at the same value and time as the obligation to surrender NZUs, again producing a nil result. Timing The free allocation of the NZUs should be taxable on an accrual basis and taxpayers should have flexibility on when they return this income, that is, the free NZU should be deemed to be derived based on an emerging basis that reflects their business. The Group believes that the method taxpayers adopt for financial reporting purposes should also be legislated as acceptable for tax purposes.
Page 6 of 8 The value attributed to free NZUs which have been derived under the taxpayers emerging basis, should not be the market value at year end, rather it should be the market value at the time when the NZUs are issued to the taxpayer (i.e. the opening market value) or the market value at the time when the NZUs are treated as being derived (i.e. throughout the income year, namely an average market value). The Group believes that taxpayers should have certainty with respect to the income from holding NZUs hence our submission that they should not be valued at year end market value. Noting that if the derived free NZUs are required to be valued at the year end market value, this will give rise to material fluctuations in income tax liabilities which could inappropriately expose such taxpayers to use of money interest. Adopting this approach there is no need to separately value free NZUs held at year end for tax purposes as there should be no mark to market type calculation done each year in relation to NZUs. Free NZUs sold during the year should result in the full net gain or loss (not already recognised) to be recognised in the year of sale. A reason for the above treatment is that the Group believes that taxpayers should return income and pay provisional tax with some certainty; unexpected gains/losses from disposing of NZUs should be deferred until when those NZUs are sold. At the extreme, the proposed Scheme operates with all taxpayers having to settle obligations on 31 March for the calendar year; on that date the market price of NZUs could have a price spike. It would be totally inappropriate for March balance date taxpayers to use such a price to value excess NZUs on hand. Acquired NZUs to meet NZU obligations (i.e. which will be on revenue account) NZUs acquired by taxpayers during a year should be deductible when incurred. At year end, NZUs acquired by taxpayers that are not attributable to that years carbon obligations should be added back for tax purposes in accordance with section EA 3 principles and deducted in the following year. In relation to excess NZUs acquired during the year (i.e. those NZUs that will not in any way be used for that year) the Group also recommends that to the extent that such NZUs have reduced in value during the period that this reduction in value can be deducted during the period. This is the equivalent of valuing such NZUs at the lower of cost or market value. The Group acknowledges officials position that excepted financial arrangements are only able to be valued at cost, not the lower of cost or market value. Clearly other forms of trading stock can be valued at the lower of cost or market value. The Group believes that this is the correct approach for valuing excess NZUs (i.e. acquired NZU in excess of the taxpayer s obligations at year end). This is because: If taxpayers are forced to value at the cost, should the price reduce below its cost, taxpayers will be forced to sell excess NZUs prior to year end to obtain the tax deduction (otherwise they will only have a deferred tax asset). While taxpayers may make these commercial decisions, we are concerned that the Inland Revenue may argue that this amounts to tax avoidance; we see no economic benefit in having any regime that provides this uncertainty. For accounting purposes, the Group understands that taxpayers will value at the lower of cost or market with the proviso that they can opt to value at fair value (if there is an active market). That is, many taxpayers will simply value at the lower of cost or market and they should not be forced to apply different tax treatment as this only raises compliance costs.
Page 7 of 8 The rationale for valuing excepted financial arrangements (i.e. shares) at cost was to limit the ability for taxpayers to defer recognition of gains (by valuing shares that have increased in value at cost), but recognise unrealised losses (by valuing shares that have lost value at market value). We understand officials were most concerned with situations where such taxpayers had overall net gains in equity holdings but, given the ability to claim unrealised losses, had net tax losses. To prevent taxpayers only market valuing losses, all shares that are held on revenue account now have to be valued at cost. We believe that this rationale should not apply to NZUs as the purpose of purchasing NZUs is to meet emissions obligations over the short term rather than to speculate on the change in NZUs value over time. Tax deductibility The Group believes that the standard tax deductibility provisions in the Income Tax Act should be sufficient to provide deductions for expenditure incurred by taxpayers relating to emission obligations, including any costs associated with the trading of NZU and any other charges imposed on emitters under the Scheme. However, to provide certainty to taxpayers the Group believes that the insertion of a deductibility provision in the Act would put the matter beyond doubt for taxpayers. An alternative would be to outline the tax deductibility of costs associated with meeting emissions obligation in a Tax Information Bulletin. The Group also believes that penalties imposed under the Scheme should be deductible to taxpayers when the taxpayer did not intentionally fail to meet their obligations under the Scheme. For example, if a taxpayer accidentally underestimated their obligation they would potentially be penalised under the Scheme at a fixed price per tonne of carbon shortfall. Generally penalties are not deductible under public policy grounds when the activity resulting in the penalty is considered too remote from the income earning process and the taxpayer should not receive favourable treatment when they have done a wrongful act (e.g. traffic fines). However, in relation to the Scheme many of the penalties appear to be for calculation and interpretation issues (e.g. different interpretation for measurement of emissions); such penalties should be tax deductible. This is especially relevant given the science and technology involved in measuring emissions is new to both taxpayers and the Inland Revenue, and can be subjective. Further the nature of the current proposed penalties mean that penalties under the Scheme are virtually inevitable from time to time reinforcing that public policy should not apply to deny a deduction for the penalty imposed under the Scheme. Accrual of NZU obligations At year end taxpayers that have not acquired sufficient NZUs to meet their obligations for that year can accrue for tax purposes an amount of estimated expenditure expected to be incurred to purchase NZUs to meet their obligations. The Group believes that the method taxpayers adopt for financial reporting purposes should also be legislated as acceptable for tax purposes. The Group therefore supports officials view that deductions should be available as the taxpayer incurs obligations under the Scheme. That is, taxpayers should be able to accrue a liability for cost of acquiring NZUs to satisfy their obligations for emitting greenhouse gases. This treatment is consistent with general principles.
Page 8 of 8 GST To ensure simplicity when NZUs are traded the Group recommends that a supply of NZUs should be zero rated. The Group does not support having GST charged at 12.5% on the transfer of NZUs. The concern the Group has with the transfer of NZUs at 12.5% GST is that it will add considerable complexity and uncertainty when taxpayers acquire (and sell) NZUs, especially should the NZUs trade on a market. Specifically, before anyone will know what price to pay for a NZU they will need to know: 1. Whether the price of the NZUs quoted is GST inclusive or exclusive (including whether the vendor is resident or not) 2. Whether appropriate tax invoices will be issued, and when they will be issued. That is, subject to understanding exactly how the regime will operate, the GST implications could materially impact on the efficiency and effectiveness of the market. For example, a taxpayer would not want to pay $112.50 (being $100 plus GST of $12.50) for an NZU until they were absolutely sure that they could recover the $12.50 as GST input tax. The above also raises a number of system changes that would need to be incorporated into a market trading system. Overlaying the above, we can not see any tax policy rationale why NZUs should have GST charged at 12.5%. Specifically, we suspect all (New Zealand) taxpayers that will be acquiring NZUs to meet obligations under the Scheme will be GST registered and the acquisition of the NZUs will be in the course of furtherance of a taxable activity. That is they will recover all GST input tax charged. Where taxpayers are simply trading in NZUs, there should be no GST cost from trading in them. That is, if GST is to be charged at 12.5%, then they should be able to recover all GST input tax and pay GST output tax on the sale of the NZUs. We see no economic or tax policy gain from having such taxpayers account for GST, rather we see material implications for the smooth running of an efficient and effective market (as discussed above). Consistent with this proposed treatment the Group notes that there is no underlying supply of a good or service. While it is stated in the paper that a NZU is a chose in action, the Group considers that it is more akin to a penalty (for emitting) or a proxy for a tax. Imposing GST on top of the price of the NZU would be effectively imposing a tax on a tax.