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Budget Podcast – John Peterson, Vicki Ammundsen and Sybrand van Schalkwyk

John Peterson and Vicki Ammundsen join me on this first TalkTax podcast.  Hope you enjoy our thoughts on the Budget released today.  Please leave a comment below.

Click on this link to listen: Thoughts on the Budget

The transcript of the podcast is copied below:

Sybrand: Hi I’m Sybrand van Schalkwyk from Parry Field Lawyers, thanks for joining us today on the first podcast of its kind on this blog. In today’s podcast we will be considering the main proposals released in the Budget with a specific focus on the impact it will have on business and individuals alike. Joining me today is John Peterson, Tax Partner and Minter Ellison in Wellington and Vicki Ammundsen, Parter with Ayers Legal in Auckland to discuss the major ramifications of the budget.

John will be discussing the issues surrounding the alignment of tax rates and Vicki will be sharing her thoughts on the implications of the changes to the taxation of investment property, and also after that Vicki and I will have a bit of discussion about the increase in the rate of GST.

Now John, let’s talk alignment of tax rates. Firstly, can you just summarise what’s happening, and give us your take on it.

John: Yes, the big headline grabber in relation to this budget is going to be the cutting of the top tax rate from 38% down to 33, which is a big tax cut for us. Just a back of the envelope calculation, if you’re on a $100,000 dollars a year that’s going to be a tax credit that’s worth about $3,600 a year to you as a tax cut. At the bottom rate it’s looking a little more modest so if you’re on $50,000 a year your tax cut is going to be around less than half of that. So its a tax cut that is or a budget that favours the top end of the income scale. So the issues, the big headline grabbers are going to be around whether, the equity of raising GST in order to fund a tax cut at the top marginal rate level and if the government has reasons that it wants to do this, it says that it wants to encourage savings and the idea would be that if you raise GST and lower income tax rates then that has an influence at the margin. And the other reason for doing this is that it aligns the top personal income tax rate with the trust rate which eliminates some of the distortion that we have seen in our tax system since the tax rates were hiked up by the Labour government, and that distortion involves diverting money through trust and corporate structure to access lower rates. And so the government feels that this move is fairer in the sense that it creates an equity between those who earn most of their income through base salary and those who earn most of their income through investments or who are business people.

Sybrand: John, do you think we will have a lot fewer trusts being set up as a result of that change?

John: I think that certainly, the marginal tax justification is gone, but there is always going to be the other advantages of a trust which is around asset protection and advisors are still going to tell their clients that there are advantages to running things through a trust structure because it puts the assets in the trust beyond the reach of the creditors and beneficiaries. So I don’t think that we are going to necessarily see a fall off in the number of trusts although I think we’re going to see a reduction in these trusts that are purely driven out of tax purposes.

Sybrand: The other thing I find slightly annoying about the tax system is that, if I’ve got investments in a PIE they’ll get taxed at 30%, if I’ve got them not in a PIE they’ll get taxed at my marginal tax rate 38% and if I’ve salary and wage income that’s 38% as well. Now with these rates being aligned is that going to go away mostly or are we still going to have a bit of that?

John: Yeah, it’s interesting isn’t it because the government, by lowering the PIE rates down to 28% to match the corporate rate which is going to go up in the 2011-12 income year, has still created the sort of wedge between the taxation of labour income and the taxation of returns on capital because an ordinary New Zealand resident can invest through a PIE structure and undergo a top final tax of 28 cents in the dollar whereas if they don’t hold it through a PIE structure or if they earn that income through their own labours then it gets taxed at a higher rate which is up to 33%, so the government has still preserved what the Labour government created when it introduced the PIE regime which was an express decision to tax returns on capital at a lower rate than returns on labour, the National government seems to have stuck with that policy in functional terms because we have a 5% wedge between the top marginal personal rate and the return on PIE’s. So those distortions still exist in the system but they may be deliberate distortions because one of the things the government is focussed on in macro economic terms is trying to get New Zealanders to save and this is a way to do so.

Sybrand: One thing that might happen is a client comes in and says “I’ve got a lot of money sitting around, shall I put it in a trust or just put it straight in a PIE”, I’d be saying to this client put it straight in a PIE.

John: Yeah that’s right, of course that then depends on there being PIE’s that represent whatever particular portfolio selection your client wants right, and currently PIE’s  tend to be vehicles that are investing in shares, there are some property PIE’s out there and some debt PIE’s in the form of these cash PIE’s that the banks offer. But there isn’t necessarily a broad range of investment opportunities that are in PIE form but the government does seem to be continuing or perpetuating this tax advantage that they have and perhaps we’ll see more activity in the managed funds base if this distinction is embedded in our tax system and carries on we might see further funds being offered that have different rates of investment to your client.

Sybrand: The other thing I just, sorry I interrupted you, was there anything else you wanted to say on the rate alignment?

John: Well I think that there’s going to be an equity concern here, and no doubt the press will pick this up tomorrow morning but it’s not obvious to me that is entirely equitable to be giving a tax cut of 5 cents in the dollar to people at the top marginal rate and funding that out of effectively GST receipts when it tends to be lower income earners who spend a large proportion of their income on GST personal supplies, and you know the government has put some spin around this in the sense that it’s saying well if that income that you earn is applied to paying down your mortgage then that’s not subject to GST and so look you’ll be better off on any calculation. I think there is no getting away from the undeniable fact that this is wealth redistribution upwards on the income chart and so I think that is something that will get a lot of press in the papers over the weekend.

Sybrand: One other thing I just wanted to talk to you about was this reduction in the Thin Cap Safe Harbour from

John: 75 down to 60 isn’t it?

Sybrand: Yes

John: That’s more in line with international standards and the thing that we have in New Zealand is of course, that we are pretty lenient about the way we tax non-residents who invest through debt instruments into New Zealand, there is the AIL regime which is a small levy that we charge on those kind of interest returns and we incentivise non-residents to come into this country in the form of debt, so that lowering this thin cap ratio just releases some of the leverage or changes the leverage outcomes around investing in New Zealand. Its going to be interesting because it may change the way that capital is priced in the New Zealand economy, you can’t really predict at this point how that will play out but I don’t think that we are making a move here that is necessarily out of line, with the US for example I understand that there is a similar thin cap ratio and we see similar things in the context of Australia. The difficulty with thin cap always is that if you set a bright line test like that people tend to, or investors tend to structure their debt arrangements so that they come up close to the line but don’t cross it so that I think we found out that with the rate of 75% people were structuring their arrangements so that they were 72 or 70% debt funded which was thought to be unacceptable.

Sybrand: Great, well thanks a lot for your thoughts and we’ll flick over to Vicki and I’ll talk to her about the other things. Thanks a lot John.

John: Thanks Sybrand.

Sybrand: Just talking about the changes to the taxation of property income and investment properties, what are your thoughts on that?

Vicki: I think that the first thing I would say is that the good thing is that now we have some certainty, I think we are all aware that there have been a lot of investors sitting back and not really doing anything because they haven’t known what the changes are going to be and so I think that has put a lot of people in a hold mode. Now we know what we’re looking at so people can sort of get back to business and I think that’s a really important thing. I think for property investors I think they may feel that they’ve been a little targeted harder than they expected, removing the 20% loading is going to hit some hard and I think probably what will happen is there’ll be a pretty hard look for some at the definitional issues over the 50 year life span and I think that we would expect to see some people looking more closely at what they are buying and whether or not they’re going to be able to get around it by having shorter life spans. Where they’re going to have to be careful though, is that banks might start taking a second look at the value of the securities as people try to get clever. So its my fear another situation where if you make a tax driven move you’re going to end up with another problem.

Sybrand: So is this the point about investment properties being, well if you’ve got a property and it’s life time is more than 50 years then your depreciation on that property and that building will go to 0%. So this is the point, so there’s going to be a definitional issue at 50 years and some people are going to try and squeeze under 50 and some are over. So what you’re saying is…

Vicki: Its inevitable that commercial investors will look at the loss of that depreciation, that’s going to hit some bottom lines really hard and its inevitable that people are going to look at whether or not they can find a way not to have it not apply to them. But they’re going to have to take care because they might win on one side and lose on the other with banks taking a closer look at the value of securities.

Sybrand: Yeah, so what people are saying is, well this property isn’t worth, isn’t going to survive for 50 years, you know for tax purposes, and then the bank will say, Oh, so you say this property isn’t going to be around for the next 50 years so it can’t be worth as much as what you are saying it is.

Vicki: Exactly

Sybrand: So that’s the dynamic that will come to play.

Vicki: There’ll be a bit of tension there I think.

Sybrand: What do you think of this move to treat LAQCs and QCs as Limited Partnerships?

Vicki: I think again people are going to have to be a little bit careful because maybe the, you know obviously it’s perhaps a better treatment than was expected, there was talk of losses being ring fenced and other treatments in place that would have ended up with some questionable policy, motives coming out of it. I think it could have been a lot worse for investors. On the plus side people can maintain their existing structures and LAQC’s and qualifying companies have a lot, at the moment, have all the benefits of personal ownership but with the protection of a corporate structure. On the down side, because we don’t know enough about what the new rules are going to be if we’re going to be taxed, like as for a limited liability partnership, for a limited partnership, the loss limitation rules that apply to those partnerships if those are going to apply the flow through of losses may not be at the total level that people are currently used to.

Sybrand: Yeah I think…

Vicki: But again, we’re going to need some detail so we know exactly what we are looking at there.

Sybrand: Well apparently the policy advice division is going to release a discussion paper on this today but I’ve not seen it on their website yet so…

Vicki: Yeah, I’ve been looking as well for a bit of guidance…

Sybrand: But I think you are right, and I think, well I don’t know whether people will, you know normal commentators will, non tax specialist commentators will appreciate that this limited partnership treatment has an impact on the losses flowing back. Just to summarise, my understanding of the limited partnership loss carry through rule is that you can still carry some losses through but you can only carry it through to the extent that, as they call it, ‘you’ve got skin in the game’. So to the extent that you’re not exposed to any actual loss, to the extent that you’ve haven’t got your equity invested in this property, you can’t get any losses, so for those people who borrow all their money to invest in an investment property because they haven’t got ‘any skin in the game’ they won’t be able to get any losses that come through to offset against their personal tax liability. Would you agree with that, does that make sense to you?

Vicki: It does, because how it works, the formula on a partnership, you know its not a completely straightforward partnership but you’re looking at, you’ve got to have had a real economic loss to be able to get your loss back and so I think that there might be some really sharp bitey bits that go with this and I look forward to seeing what the form of its going to take. And of course what people do have the option of is saying well actually I want all my losses and go back perhaps to personal ownership where effectively they can claim all their losses back and they’ll be in the same position as if they had an LAQC only they won’t have the corporate protective structure that goes with it. So again its a matter of people looking at the pluses and minuses of it and getting used to some new rules and perhaps paying a bit of attention to the fine detail because those details, the devil will be in the detail here I think. And maybe, although this looks as if its been a better budget than investors expected, they might start to find that when they start to drill down a bit that there are some hidden scary bits.

Sybrand: Is what we’re going to see, if I’ve got an investment property and it’s only a rental, I think this is where the most abuse has arisen, where you’ve got one normal guy who works for wage and salary and he buys an investment property and rents it out in LAQC and gets the losses to come through to offset against his wages. Now if I was that guy all I would do is sell that property from the LAQC straight into my own name and then I’m in exactly the same position as I was before. I don’t really need limited liability because you know, what’s going to go wrong the tenant’s going to burn the house down I’ve got insurance for that, but there’s very little other, you know things I need limited liability for. Even if I’ve got a mortgage on the property, the banks going to say well we want you to personally guarantee this mortgage anyway, so limited liability doesn’t help me there either.

Vicki: For the small investors I absolutely agree with you, with bigger investors where the corporate structure is still useful is if you want to exit the investment and not, for example, have to worry about previous depreciation recovery income so that you’re selling the shares on the company rather than the investment. You’ve still got some advantages in that corporate structure. But for some investors if the rules are going to make it harder, yes, the right treatment might be to take it back to personal ownership.

Sybrand: Yes, and so that could result in a lot of work for Tax professionals and good news for you and me…

Vicki: And for Conveyancing lawyers who need all the work they can get…

Sybrand: Good news for you and me but I suppose its not such good news for those people who do own those if that means they have to restructure but as you say, the devils in the detail with this and we will have to wait till that report comes through from policy advice.

Vicki: Well we need the report through but I think for people its going to be a matter of getting a bit of advice and possibly not from the neighbour over the fence but spending half an hour or an hour with their accountant or lawyer and actually having someone advice what the new rules will mean for them in their situation so they can make informed decisions.

Sybrand: Sounds like a good idea to me.

Vicki: But at least I think that we know what we’re dealing with now and I think that’s a good thing.

Sybrand: Yeah, I think you’re right and I think that will take that uncertainty out of the market. Umm, can we talk about GST.

Vicki: Lets…

Sybrand: I’ll give a bit of a summary. There isn’t really much in the budget on GST apart from the fact that the rate is increasing from 12.5% to 15%. And on the other side of the ledger, most of the benefits are increasing by something like 2.2%. Now the argument for the increase in the benefits by 2.2% is that government has got Statistics New Zealand to look at the price impact the increase in GST will have. Statistics NZ have come back and said, well, its going to have roughly a 2.2% impact. And so what the government is doing is saying, OK, we’re increasing the GST rate but we’re going to offset the regressivity of the tax, so in other words it taxes poor people harsher by increasing the benefits to those people. Now I just quickly want to talk about what I think will be the main issues that people have to consider from this increase. When you think about GST it’s really a tax collected by businesses, so the greatest impact from a system or a collection mechanism change will be on businesses, so, and this is all the sort of normal things that you see being talked about, you’re going to have to increase your prices, it’s going to have to be increased on the 1st October so you might have to employ extra staff to do that. The other point that you’re going to have to look at is your systems, is your accounting system up to scratch, can it deal with two rates at the same time. In most cases accounting systems can but in some cases I think people will find a 12.5% rate has been hard coded in.

Vicki: I think too, we’re going to get used to the maths of dividing by 7.667 to work out the GST, but I think for business people dealing with the administration that goes with this, they’re all going to take a hit, because there are real costs involved and depending on the market that you’re in, for someone like me as a lawyer its relatively straight forward and from the data documentation, the invoices are prepared and the new amount goes on and the systems are changed and its relatively straight forward. However, for people in retail a lot of products are made offshore and are priced, so there’s retailers who will be looking, need to be looking, right now at their packaging and what’s happening to make sure that the packaging that’s being prepared right now’s going to reflect the new price. And of course it isn’t as simple as just raising the price because you do have some products out there where there are market sensitivities and price points beyond which the market will not or is reluctant to move and retailers are going to be making hard decisions about are they just going to put the increase on across the board or is it going to be more likely to be a line by line anaylsis of each product and saying will this product bare the increase or do I have to leave it at its existing price of 12.95 or 5.99 because I know my consumers won’t pay more. And supermarket lines that’s going to be an industry where they’re going to be burning the midnight oil and putting a lot of work into those decisions because they’re not always across the board.

Sybrand: I think you’re right. Well can I just unpack this, do you think this is going to be simple for you as a legal firm to deal with this, are you on a payments basis or a invoice basis?

Vicki: Apart from the straight transitional issues, because we’re in a service industry it is relatively straight forward and we’re not dealing in a market where we’re dealing with packaged prices or you can always do this for $199, you know I think for us and obviously we will look at some of the products we offer and whether or not clients, and a good example might be wills where people are particularly price sensitive and we’ll be making decisions on those products and whether we increase them to reflect the increase in GST or whether we just change or we hold the existing pricing. But for most things we charge on an hourly basis and so I see it for us as being a bit more straight forward than for people who are in the business of selling products and have a whole range of products that they are going to be analysing.

Sybrand: Yeah, I think you’re right. I think that’s right, I suppose I’m just trying to unpack the transitional rules and the situation I can think of is you’ve got someone on a payments basis and they invoice before the rate change but they only get paid after the rate change. Now because they’re on a payments basis, they only account for GST when they receive the payment so the invoice will say 12.5% but when they receive the payment the rate will actually be 15%. Now because the rate was changed in 1989, we’ve got good transitional rules that will deal with that and what they say is that if 1 October falls in the middle of your GST return period then you’ve got to do an extra GST return and also you have to do an adjustment for all those kinds of straddle transactions if you’re on a payments basis. And it could end up if you’ve got more output tax situations than input tax situations then you’ve got a one off hit on the 1st October that you didn’t budget for. However, if your input tax is more than your output tax you might end up in a refund situation but this is quite a peculiar bit in the transitional rules in that that refund isn’t refundable you can just carry it forward. (Editors note: Budget day legislation changes this position) So its going to be interesting to see how the IRD deals with that, presumably the new system can deal with that otherwise they might have to make changes. But it will also be interesting to see how people deal with it, I’m sure its going to be difficult.

Vicki: And the people who’ve got to be so particularly careful is people who use GST inclusive pricing structures rather than plus GST pricing structures so that if people aren’t reviewing the forms of contract that they use they’re going to be needing to be making sure that they are using documentation that allows them to recover at the new rate.

Sybrand: Yeah, I think that’s right. Let’s just quickly talk from a policy perspective. I think its a good idea, and the way that the government has rationalised this is they’ve said consumption tax is tax of consumption so it will encourage saving. As a growing economy we should be encouraging saving because our debt levels are astronomical. I think that they are quoting something like if you take all our debt, I’m no expert on this, but private and government debt then it comes to 90% of our GDP which they are saying is very high internationally. But what the GST does is encourages people to save because it doesn’t tax you on your savings but it taxes you on your consumption. What’s your take, what do you think of that?

Vicki: I certainly agree with you and I think that saving, as a country we have an appalling savings record, we are by nature, we invest in property, we look at things that will be our investments but we don’t actually, we are relying on capital gains to create our savings rather than having any active savings basis and we’re an aging population where we’ve got the shape of our population is looking increasingly unattractive, and when you’re looking at who is going to be funding us in our retirement we are going to have to move away from the notion of superannuation to fund us and we have to start taking on responsibility for our own savings. From a policy perspective the next step I think, if things don’t move around, is there will be, I would expect to see compulsory superannuation back on the table.

Sybrand: Yeah I think that’s right…

Vicki: As a consumption tax, I mean I’ll completely declare my own bias, I’m completely pro consumption taxes verses income taxes, simply because a consumption tax its a flat tax across the board and you can choose the level at which you choose to participate in a consumption tax and, although we’re not all going to be growing fields of cotton in our backyard so that we can weave our own clothing, we can choose the level at which we consume. And the full impact of the increase in it we can choose ourselves how much of that we’re going to, how much of it we will wear and whether or not we are going to consume.

Sybrand: Umm, I think that’s right, John Key said that he will resign if super goes so unlikely to happen in this time. But the other measures, well if the government runs out of money, or a different government comes in, I can easily see that the GST rate remains at 15% and our personal taxes go up again or the company rate goes up again. I think internationally corporate rates are going up, people are being taxed on the personal capacity at higher rates as well because of the debt problems..

Vicki: In some ways what New Zealand is doing is almost the opposite, bucking the trend of the rest of the world where we’re seeing increased taxes and decreased consumption taxes so we’re doing almost the opposite thing.

Sybrand: That’s right, well I think there is a trend for increasing indirect taxes as well, although in the UK the indirect tax went briefly from 17.5% to 15% but its back up at 17.5% again. Yeah…

Vicki: The greatest thing about a consumption tax is that it is very hard to avoid and income tax, you know the rates we’ve had, with the misalignment we’ve had between the top marginal tax rate and the trust rate and now the company rate in a different spot, you end up with huge scope for manipulation and a lot of energies and policy efforts go into to trying to deal with what accompanies that. Consumption tax you can’t avoid it.

Sybrand: Yeah, I think that’s right.

Vicki: If you choose to consume. And your black market economy which sits away there in the corner, its very difficult to, you know you can choose not to pay, not to declare your taxes and hopefully you’re going to get caught. Consumption tax you can’t really avoid that if you’re out there in the market. I think from a cost of collection, I mean I see that revenue has got more money in the budget for targeting different areas of avoidance or abuse, but avoiding GST is pretty harsh.

Sybrand: Well I think that pretty much wraps up the time that we’ve got for today..

Vicki: I’m just going to finish on one little thing that’s kind of not relevant to what we were talking about but I was delighted to hear the comments made regarding trusts which started off as, appeared to be suggesting that their widespread use as a tax planning vehicle and I was very relieved to hear the tail end of that comment that they are an important role in our economy but shouldn’t be designed and be driven simply by tax advantages and it would be nice to see trusts perhaps being put to better use than just abusing the tax rates that we’ve had.

Sybrand: Great, well thanks for that thought.

Vicki: A pleasure.

Sybrand: Just in conclusion to this podcast, we hope to have some more in the future, and also we’d be very interested in anybody’s thoughts on this podcast, just put them in on the bottom of the post and we’ll be interested to read that. I think that’s one great advantage of a public forum like a blog and you can really get a good feel for what’s happening at grass roots, it can keep you up to date with current developments and commentary like this one. I’ve really enjoyed the discussion with you today Vicki and with John and thanks for volunteering your time and also to CCH, thanks for making this possible, and I’d also like to thank Gideon Shalwick from who has given me some technical assistance, without him I wouldn’t have been able to do this. So thanks a lot for that Vicki and hope to see you all again soon.

Vicki: A pleasure. Thank you, Goodbye.

For other articles relating to New Zealand law refer to our firm’s New Zealand Lawyers blog.

6 Responses

Carla Cross on May 21, 2010 at 9:57 am

I really enjoyed listening to the pod-cast! There were some interesting ideas talked about, especially those relating to investments in PIEs now that the tax rates will be reduced and the proposals for changes to the LAQC regime . An excellent conversation on all tax aspects of the Budget. The pod-cast adds alot to the debate – not just a regurgitation of the Finance Minister’s speech. Well done to Sybrand, John and Vicki!

Paul Francis on May 21, 2010 at 11:48 am

Thanks for a useful discussion of the budget.

Id be interested to hear more comment on transitional rules for GST relating to property.

Terry Baucher on May 21, 2010 at 2:40 pm

The proposed changes to the QC regime are really ugly. Although they are clearly targeted at residential property investors, the collateral damage could be extensive. Investors in forestry partnerships in particular should have real concerns about the proposed changes.

What’s particularly bewildering is that the change can be circumvented through alternative ownership structures and raise relatively little money. $70 million in 2011/12 and $55 million for 2013/14. Does that really justify such a dramatic change?

Gabrielle and Ray on May 22, 2010 at 12:34 am

Informative and most helpful. We look forward to further podcasts.

Carlton on June 14, 2010 at 12:26 am

Very insightful and helpful. Thanks to Sybrand, John and Vicki!

Gabrielle and Ray on May 19, 2011 at 5:59 pm

Type your comment here.
Thanks for that – good discussion and informative.

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