TAX POLICY DURING AND AFTER THE COVID-19 PANDEMIC
A huge effort is going into New Zealand’s health response to the COVID-19 pandemic. Despite debate over whether we have locked down too tightly, we have generally been served well by our senior public servants and politicians, who have been prepared to confront hard issues, make hard choices and face still more hard decisions to come. Inevitably those decisions will focus on four pillars - how we:
- continue to protect the health of our population;
- restart and sustain economic activity;
- avoid the risk of major social disruption; and
- rebuild the resources of the nation, given what has been committed thus far and will inevitably be committed in the future.
Taxation policy, law and administration will play a very important role in our national response to the challenges that lie ahead. Those challenges have a new core reality that not many people yet grasp. New Zealand is now, and is likely to remain for some time, a very much poorer nation than we considered ourselves before the arrival on our shores of the Coronavirus. That new core reality will make the development of tax policy even more of a delicate balancing act than it has traditionally been. Louis XIV’s Finance Minister, Jean-Baptiste Colbert, famously declared that, “the art of taxation consists in so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing.” New Zealand will not have that many geese in the foreseeable future and those that we do have may have sparse and ragged plumage. They are unlikely to be ripe for a plucking.
On the eve of a decision about easing our level 4 lock down we can review the tax-related steps taken thus far in the face of the pandemic and consider where New Zealand’s tax system may need to go in order to address the four pillars referred to above. Past emergencies and the tax responses to them provide some guidance, though not a crystal ball.
The focus thus far both here and abroad has been on keeping the economy going, albeit at a significantly lower pace, keeping people connected with their employment and employers, while the majority of us are in isolation at home. In that context tax policy has already been applied to try to achieve these ends along with more direct stimulus. Immediate steps have been to offer temporary extensions to filing and payment deadlines, together with relief from tax obligations and some modest tax incentives to free up cash for businesses to continue to pay staff. A strange option was adopted in reinstating commercial building depreciation and a very modest adjustment to provisional tax thresholds was intended to relieve some taxpayers of the need to divert cash flow to meet provisional tax payments. A second tranche of measures has included a loss carry back scheme. Again, this is directed at freeing up cash for immediate redirection, given that it coincides with the third and final provisional tax payment date on 7 May 2020. Inland Revenue is also working through a range of options that will see further policy changes announced in coming weeks.
Current predictions are that New Zealand's GDP will contract by 5 to 10 percent compared to 2 to 3 percent during 2009's global financial crisis (“GFC”), and unemployment is expected to climb to double-digits. If predictions of a general depression come to pass, the position could be very much worse.Given this, economic stimulus will be crucial to get the economy back on track.
However, at some point our Government will need to reassess its strategy to balance stimulus with consolidation. This need will be exacerbated in New Zealand by the fact that every dollar injected into the economy by way of stimulus will have been borrowed. Countries all around the wold are doing the same as New Zealand. We complete for money and there will be upward pressure on the price we have to pay for the billions we are borrowing to pay for the four pillars. With debt servicing costs likely to increase substantially at a time when tax revenues are likely to decline significantly, pressure will mount on the Treasury to identify ways of maximising Government revenues. This will doubtlessly lead to tax policy focused on maximising the breadth of the tax base, to start to refill government coffers. However, what this tax policy might look like in a new economic reality, that is still largely unknown, is very uncertain indeed.
This note highlights what tax policy governments around the world are employing to stimulate their economies and explores what tax policy might be adopted during the recovery phase.
Given the uncertainty of the duration of enforced isolation and the social and economic impacts of the COVID-19 pandemic, this note is a working document that will be updated as developments unfold.
What are other governments doing?
The OECD has quickly reflected on the current situation and suggested governments consider introducing the following measures:
- Waiver or deferral of social security contributions (in New Zealand reflected in the ability to take a Kiwisaver holiday);
- Tax concessions for essential workers;
- Affording taxpayers additional time to deal with tax affairs;
- Deferring VAT and duties for imported items (particularly medical supplies and personal protective equipment);
- Deferring advance payments of income tax;
- Increasing the generosity of tax loss carry forward;
- Speeding up the processing of tax refunds; and
- Simplifying the procedures for claiming bad debt relief.
Many countries have adopted a range of these measures. Others have done more. At perhaps the most extreme end of the spectrum, Italy has totally suspended its tax system, including all filing and payment obligations. Some European countries have temporarily reduced VAT as many did during the GFC. Probably the most common concession is relaxing filing deadlines and the general remission of penalties and interest. Some countries have also suspended all tax audits – although it would be difficult to see how an audit could effectively progress while taxpayers and revenue officials are in lockdown anyway.
What is our Government doing?
The New Zealand Government has acted quickly to introduce a number of measures aimed at freeing up cash for struggling businesses. Principal amongst these is the wage subsidy scheme administered by the Ministry of Social Development (“MSD”). Although not a tax incentive, the related mechanism facilitating information sharing between MSD and Inland Revenue is likely to mean that those participating in the scheme may expose themselves to audit activity in the future. More on this below.
The tax incentives announced by the Government so far are:
- Expediting the refundability of research and development (“R&D”) credits. This measure was already scheduled but has been brought forward. This will enable more loss-making and pre-profit businesses to access refundable R&D tax credits in cash, instead of using them to reduce their income tax payable.
- Restoring building depreciation for commercial buildings. New Zealand has been an outlier on this for some time and the issue was on Inland Revenue’s radar, but the current climate has expedited the change that had been expected. The change applies from the 2020/21 tax year and permits commercial building owners to depreciate these assets at 2% diminishing value or 1.5% straight line. The Minister of Finance, Grant Robertson, explained that the reintroduction of depreciation for non-residential buildings is intended to provide help with cash flow for businesses during the COVID‑19 pandemic. It is also intended to support economic recovery following the COVID-19 outbreak by removing a tax distortion that discourages investment in commercial buildings.
- Raising provisional tax thresholds. To help support cashflow for businesses during the COVID-19 outbreak, the threshold for having to pay provisional tax is being raised from $2,500 to $5,000 of residual income tax. Apparently this measure will mean that 95,000 taxpayers who would otherwise have been required to pay provisional tax will have that cash to stay afloat until normal business operations resume. This is a permanent change.
- Raising the low value asset deduction threshold. In an attempt to encourage spending, taxpayers will temporarily be permitted to deduct the full value of assets purchases up to the value of $5,000. The threshold was previously just $500. The concession will expire on 17 March 2021 where after the threshold will be $1,000.
- Remission of use of money interest (“UOMI”). Inland Revenue has been afforded greater discretion to remit UOMI when a taxpayer’s ability to pay tax was significantly affected by the COVID-19 outbreak, and the tax payment was due on or after 14 February 2020. Further guidance is expected from Inland Revenue but circumstances where Inland Revenue will agree to a remission are expected to include where the taxpayer was quarantined and physically unable to make the payment, or (perhaps more importantly) where the taxpayer does not have the financial means to pay due to the economic impact of the COVID-19 pandemic. Note that this is not a general remission, but on its face appears to be something considerably narrower. It remains to be seen whether Inland Revenue will be prepared to apply the concession broadly to ensure that more circumstances arising as a direct consequence of the COVID-19 outbreak are covered. Early indications are that this will be the case, as at 1 April 2020 a note on Inland Revenue’s website generously reads: “We will write-off any penalties and interest for businesses unable to pay taxes on time due to the impact of COVID-19.”
- Extension of 2018/19 income tax return filing deadline. These income tax returns were due to be filed by 31 March 2020. Inland Revenue has announced however that any late filing penalties will be waived. Late tax return filings would normally have had the effect of extending the time bar in section 108 of the Tax Administration Act 1994 to 31 March 2025 (instead of 31 March 2024). Notwithstanding this, it has been announced that due to the impact of COVID-19 and related potential for filing delays, as at 31 March 2024 the Commissioner will close any review or other compliance activity for any 2018/19 income tax return which is:
due on or before 31 March 2020 and is furnished after 31 March 2020 but before 31 May 2020;
not subject to any existing exclusions from the standard 4 year time bar;
not subject to a dispute:
commenced by Notice of Proposed Adjustment issued before 1 January 2023, and
not involving alleged tax avoidance, or
having tax in dispute of greater than $200 million.
What else can we expect to see?
With a sever economic downturn predicted we will certainly see tax policy used to revive the economy. Sectors of the economy likely to be relied on, such as the export sector, have spoken against the use of direct export tax incentives such as those that were part of our tax landscape in the late 1970s and early 1980s. They were of questionable utility and arbitrary in their reach and application. More subtle tax levers will be applied though when consolidating the national balance sheet, collecting money will be more important than paying it out. At present, one can only speculate what measures might be employed by the Government in the short-term. Accordingly, the list below ought to viewed with a degree of circumspection.
- Expediting expected relaxation of loss continuity requirements? A discussion document on the relaxation of loss continuity requirements was expected to be released for consultation later this year. Proposed changes could be brought forward or be more generous than originally contemplated. Such changes could stimulate investment in struggling businesses by locking-in the benefit of historic tax losses for new owners who carry on the same or similar business. Present indications are that this not an option that IR favours but it may be important in a response to the protection of New Zealand enterprises from predatory acquisition by foreign interests, a matter that is gaining currency and concern.
- Windfall tax on the supermarket duopoly? A windfall tax is a tax levied by governments against certain industries when economic conditions allow those industries to experience above-average profits. Arguably New Zealand’s supermarket duopoly is benefiting at a time when many other related businesses are suffering. As a response to the need for some economic equity to balance the fact that some aspects of the lock down have been seen as playing favourites, a windfall profits tax on those supermarkets might find favour amongst the electorate. Of course the success of this as a revenue gathering option depends on lock down trading having been profitable, something that is as yet unknown.
- Temporary reduction of rate of GST. This was very common in Europe during the GFC. Many governments temporarily reduced the rate of VAT to encourage retail spending. A temporary reduction in GST would however give rise to compliance costs. Actions that businesses would have to take to implement the temporary GST cut would include familiarisation, re-pricing, extra book-keeping checks, extra accountancy costs, and system changes/upgrades.
What might our government do during the recovery phase?
The Minister of Finance has already indicated that the Government borrowing required to recover from the economic effects of the COVID-19 pandemic will be borne by generations to come. Although interest rates are at record lows, governments competing for funding may be forced to borrow at higher rates to satisfy overseas markets. Given this, together with a likely decline in tax revenues due to economic downturn, tax authorities will be charged with maximising the tax take. New Zealand will not be unique amongst countries trying to consolidate once in the recovery phase. Tax policy will play an important role in the likely future tinkering with our broad-base low-rate system.
Some initial thoughts as to future tax developments are:
- Expect heightened audit activity in all areas. Inland Revenue will doubtlessly invest time and resources to ensure that taxpayers are paying the right amount of tax. Cash businesses will continue to be targeted, but large corporates may also see their tax affairs combed over. We may see as routine enquires about the wage subsidy scheme – although early indications are that officials are taking a pragmatic approach to the assessment of the required 30% reduction in revenue, it remains to be seen how Inland Revenue might test this threshold issue in the future. They most certainly will have an eye out for fraudulent claims.
It is possible that allied with heightened audit activity might be a greater willingness by Inland Revenue to settle long-running enquiries and disputes in an effort to book tax revenue as soon as quickly as possible. This may well benefit some taxpayers.
Taxpaying will become even more of a matter of national duty than in the past and this may be bolstered by increased criminal and civil penalties for tax evasion.
- Clampdown on tax planning. European tax authorities took a considerably harder line in applying anti-avoidance rules in the fallout of the GFC. Funding arrangements which had hitherto been considered acceptable were closely scrutinised. Arguably New Zealand already takes a very conservative approach to tax planning so we may see no change in this area. However, when tax planning is not possible tax evasion often creeps in. That is especially so if a general economic downturn leads to cash shortages in businesses that must nevertheless pay GST and PAYE. Expect an uptick in audit work resulting in prosecutions and a review of the penalties that apply to tax evasion.
- Expediting a unified approach to tax the digitisation of the economy. The OECD and member countries had been working together on the current proposal to tax the digitisation of the economy, but progress had been slow as no country was willing to antagonise the United States, the country which was most likely to be negatively affected. The current proposal would re-allocate some profits and corresponding taxing rights to countries and jurisdictions where multi-national enterprises (“MNEs”) have their markets. It would ensure that MNEs conducting significant business in places where they do not have a physical presence be taxed in such jurisdictions, through the creation of new rules stating where tax should be paid and on what portion of profits they should be taxed.Member countries facing declining tax revenues may be reinvigorated in pursuing the current proposal. The likelihood that the United States economy will be significantly weakened by the COVID-19 pandemic may improve member countries’ negotiating positions.
- Maintenance of the company tax rate. New Zealand’s company tax rate remains one of the highest in the OECD. However, given that in 2015/16, New Zealand collected 4.4% of GDP in company tax, which was the fourth highest in the OECD, we are unlikely to see a reduction in the company tax rate. Whether a decision is made to increase the company tax rate does, however, seem unlikely, unless there is international pressure to do so.
- Introduction of a new top tax rate/higher marginal tax rates/surcharge. Immediately after the GFC the United Kingdom introduced a new top tax rate. In the 2009 budget, the then Chancellor, Alistair Darling, told United Kingdom taxpayers they faced a top tax rate of 50% as he sought to plug a record budget deficit and admitted the country would suffer as a result of what was then the biggest contraction in its economy since the second world war. Depending on the scale of the contraction in New Zealand’s economy, additional tax revenue may be sought by introducing a new top tax rate or increasing higher marginal tax rates. Any contemplated tax cuts are also likely to be scrapped, though some adjustment to marginal tax thresholds may still occur to support low to middle income earners. Watch out for a possible “temporary” COVID Reconstruction surcharge on high incomes, though the history of such a surcharge, last imposed by Prime Minister Robert Muldoon in the later 1970s is not stellar. Although only 122,000 people (about 3% of individual taxpayers) pay 24% of income tax, those geese earning over $150,000 pa will very probably be asked to accept the need to lose more of their feathers. Expect a higher rate on "super incomes - say those over $400,000.
- Means testing of national superannuation. The fundamental change in national wealth is likely to rekindle the question whether universal superannuation is affordable. Whether this is responded to by means testing or a tax surcharge proxy, it is likely to be hugely important when a good number of retirees may not need support, though presently entitled to receive it.
- Increase in the rate of GST or graduated GST. New Zealand’s rate of GST is not high when measured on a global standard. A future government might contemplate an increase in the rate of GST to boost tax revenue, but such a move is likely to be extremely unpopular and negatively impact consumer spending. One alternative would be to realign GST between staples and luxuries with a graduated scale of rates.
- Reignited capital gains tax debate. Although abandoned by the current Government, this discussion may be resumed in the face of economic downturn and the perceived inequality in the tax system around tax-free disposal of capital assets by some taxpayers. The debate is likely to be fanned if capital markets rebound and those invested in such markets are seen to have been relatively unscathed by the economic hit caused by the pandemic. It is worth recalling that, in past severe downturns, capital markets have recorded returns in excess of 50% in the first 12 months following the downturn. If that recurs the relative economic good fortune of investors will reopen calls for capital gains to be taxed. Alternatively, if capital values remain low the Government will be tempted to impose a tax from a new valuation date that allows it to “clip the ticket” on any value growth that occurs as the country’s fortunes improve.
- Reconsideration of estate duty. Estate duty or inheritance tax is very likely to be seen as one means of addressing the inter-generational equity issues posed by the national debt burden. It may be a more acceptable form of “ultimate” capital gains tax than a general CGT and an across the board resumption of an inheritance regime could be preferred rather than having a slow burn start to a general CGT, if the needs of the nation require change.
- Transaction taxes other than GST. The most obvious of these is stamp duty, still a feature of the Australian tax scene, but they could also include gift duty and payroll taxes. The first two of these were disposed of, with estate duty, because they were seen to be a drag on economic activity and the efficient growth of capital in a capital importing economy, but that will not mean anything in the face of national need.
© G D Clews, S J Davies, Old South British Chambers