Taxation (Annual Rates for 2016-17, Closely Held Companies, and Remedial Matters) Bill

I move, That the Taxation (Annual Rates for 2016-17, Closely Held Companies, and Remedial Matters) Bill be now read a first time. I nominate the Finance and Expenditure Committee to consider the bill. This large and wide-ranging tax bill proposes several suites of largely technical changes to the tax rules. The principal purpose of the proposals is to improve, strengthen, and update our tax rules so they continue to work well for taxpayers and for the Government. Changes in the economic environment, business practices, or the way that the law is interpreted can result in unintended consequences for taxpayers. These consequences may include unfairness, inefficiencies, complexities, or uncertainty, all of which affect the integrity of the tax system. Maintaining the tax rules to ensure that they continue to be responsive to change, that they work well in practice, and that compliance costs are minimised is vital for all taxpayers and for our economy to prosper and grow. The bill, therefore, continues the Government’s work in making sure that our tax system remains fit for purpose.

As I mentioned, this is a very large bill. Many of the measures that it proposes are complex and technical in nature. They are, however, generally taxpayer-friendly and will be welcomed as such by the private sector. For the sake of convenience, the bill can be viewed as comprising four main suites of measures.

The first suite proposes changes to the look-through company rules and the dividend rules as they applied to closely held companies. Although closely held companies typically have just a few shareholders, they are also a significant proportion of the total number of companies in New Zealand. Look-through companies are, in the same way as partnerships of individuals, looked though for tax purposes: income and expenditure is attributed back to owners, and they are taxed at their personal tax rates rather than at the company tax rate. It is important that the tax rules apply as intended and that the decision to convert a small business to a company is not driven by tax considerations. The proposed measures aim to simplify the current rules to reduce compliance costs and to ensure that the rules remain robust and true to their intended purpose. They include proposals addressing a number of complexities raised through consultation with the private sector, as well as proposals to tighten the eligibility rules for an entity electing to become a look-through company. The result will be a much more workable set of rules for taxpayers.

The second suite of proposed measures is intended to bolster the rules around the tax treatment of interest earned in New Zealand by foreign lenders. Changes are, therefore, proposed to the non-resident withholding tax and for approved issuer levy rules. They ensure that these taxes apply consistently to transactions that are similar in economic substance. They include changes to the non-resident withholding tax rules to ensure they apply as intended to related party debt or arrangements that are equivalent to related party debt; changes to the approved issuer levy registration process, to reduce the risk that the levy is paid on related party debt instead of the higher rate under the non-resident withholding tax rules; and correcting anomalies related to branch structures, which can be used to remove the requirement to withhold non-resident withholding tax or to pay the approved issuer levy.

The third suite of measures in the bill proposes various amendments to fine-tune the GST rules and ensure that they continue to work as intended. They include taxpayer-friendly changes, such as enabling businesses to deduct GST associated with the costs of raising capital, and allowing partially exempt businesses to use an alternative apportionment method. There are also changes to clarify the rules around the zero-rating of services provided in connection with land in New Zealand.

Finally, the fourth suite of changes contains a large number of mainly technical amendments. Although they are mostly remedial in nature, these measures are considered by the private sector to be of major importance in making sure that the tax rules work well in practice. They are part of the Government’s ongoing work to ensure that the tax rules are clear and apply as intended, and that they do not impose unnecessary compliance costs on taxpayers. Measures proposed to clarify the deduction and timing rules for aircraft engine and overhaul expenses, including those incurred by commercial aircraft operators—

💬 Fletcher Tabuteau: Bring back Todd.

—for example, will better align the timing of deductions with income arising from the use of the aircraft and will better reflect the economic basis for the overhaul process. It is certainly getting the aircraft industry excited, Mr Tabuteau.

The bill also includes a number of taxpayer-friendly measures to promote greater fairness and certainty in the tax rules. Proposed changes to the debt remission rules, for example, address a problem that can arise under the current debt remission rules when a debt is remitted between associate parties. Debt remission refers to the extinguishing of the debtor’s liability by a creditor. The reduction of the liability is treated as taxable income because it increases the wealth of the debtor. When the creditor is associated with the debtor, the creditor is denied a bad-debt reduction, resulting in income to the borrower but not a deduction to the creditor. The bill proposes to correct this asymmetric result by treating the debt as being fully repaid when a debt is remitted between related or associated parties. The proposed changes follow consultation with the private sector in February last year and are part of the Government’s efforts to ensure fairness across the tax system. This will be welcome news for group companies in corporate New Zealand, as well as smaller mum-and-dad partnerships or businesses.

Other changes proposed in the bill include amendments to improve the consistency of income tax legislation with insolvency law, correct an overreach of the current land tainting rules affecting council-controlled organisations, ensure that the tax pooling and life insurance business rules work as intended, and ensure that the Working for Families tax credit rules work correctly. The bill also adds 14 charities to the list of donee organisations with overseas purposes in schedule 32 of the Income Tax Act 2007. They are not donee organisations. As a result, donors to those charities will be eligible for tax benefits on their donations, effective from 1 April 2016. Finally, of course, the bill sets the annual rates of income tax for the 2016-17 tax year.

Many of the measures proposed in the bill have been developed through open consultation with the general public and with private sector groups. This is a particular strength of our tax system, and it helps to ensure that tax and social policy changes are well thought through. As I mentioned earlier, we live in dynamic social and economic times. It is important that our tax system remains current and in tune with change but, at the same time, that it remains fair, coherent, and unambiguous. The proposals in this bill will help to achieve those objectives and are part of the Government’s ongoing governance of the tax system. I commend the bill to the House.

Minister Woodhouse is right. It is a large tax bill. It is a remedial matters bill. Therefore, there are a number of—

💬 Hon Ruth Dyson: Remedial matters.

—matters, yes—

💬 Fletcher Tabuteau: But it’s not sexual.

—remedial matters in it. Ha, ha! It is fixing up a lot of legislation. But, you know, the thing about this tax bill—and there have been a number through the House this year—is that it is just not dealing with the really substantive issues facing our tax system. I mean, it is great that the aircraft overhaul reserves are being dealt with. I am sure those in the airline industry will be really happy about this, because, no doubt, it is something that they have petitioned the Government for for a long time. But we have a number of very serious issues in our tax system at the moment that have hit not only national headlines but also international media and have impacted upon our global reputation—things like the ability to avoid paying tax in this country, things like inequity in our whole tax system, and things like income that can be earned without any tax being paid on it. These are the really big issues—or just a couple of the really big issues—that are impacting upon the fairness, coherence, and ambitious nature of our tax system, as the Minister over there said.

If the Minister really meant what he said when he talked about a fair tax system, then it would not be this sort of bill that we would be conducting a first reading of; it would truly be an ambitious bill that really worked to deal with the inequities in the tax system that really benefit those who can afford your fancy tax lawyers to engage in a whole lot of aggressive tax planning, while those in the middle and the bottom—certainly middle New Zealand—pay their fair share and feel as if they are getting reamed day after day.

One thing I would like to talk about a little more than most—and I must say to start, and I should have said this at the beginning: we will support this bill because Labour supports every single tax bill to the select committee so that we can hear the experts’ opinions on this, so that we can get submitters in, and so that we can get a very robust debate. I must admit that in select committee we find that all parties work together to ensure that any tax legislation that comes before the House is very robust. Let me talk about look-through companies. The Minister of Revenue very briefly alluded to this. This is quite a complex area, but it is something I think is worth expanding on.

Generally, the company tax regime treats companies and shareholders as separate taxable entities. Companies are taxed at the company rate, which is 28 percent, and dividends are taxed at the shareholder rate of, say, 33 percent. It is part of the imputed dividend system. What this means is that if a company is taxed at 28 percent and hands out its dividend, if the person receiving it is on the top tax rate, then they have got to pay an extra 5 percent to bring it up to their marginal tax rate. It is fair because it is all about taxing income at the marginal rate. You would think that is what the tax system should be based around, but only some income is taxed at a taxpayer’s marginal rate; some income is tax free—for example, capital gains.

One consequence of company tax law is that capital gains are tax free to a company but are taxed when paid out as a dividend. The company can distribute capital gains tax free if that company is liquidated. Company losses are not available to offset against income of shareholders. If I invest in a company and that company makes a whole lot of loss but I also get a wage in salary, then I cannot write off that company loss against my personal income. If you want individual tax treatment, then taxpayers can use a partnership or joint venture, but it is difficult to use in a number of situations. So many investors want the advantage of a company that is limited liability, and therefore has legal protection, but the advantages of non-corporate tax treatment: i.e. capital gains, tax free, without needing to liquidate the company and access the losses.

What happened was that in 1990—and this is quite important because this is a vehicle for the vast majority of people who are accessing capital gains for free. Mr Bennett, as the chair of the Finance and Expenditure Committee, you are well aware that a decent chunk of this bill is about look-through companies. I think that if I just rambled on about this, like the Minister did, then the people listening would have no idea what we are talking about. I think it is only fair that we let people understand the sorts of issues we are dealing with. What happened in the 1990s was that the Government introduced something called a loss attributing qualifying company. What this did was it taxed at the company tax rate, capital gains were distributable tax free, and in some cases shareholders could write off the loss attributing qualifying company losses against their own personal income.

It was used a lot in the forestry industry, for example, where a forest made losses for the first 24 years and made a gain only when it was harvested. So what happened was that if an investor invested in the forestry industry, he or she could write all those losses off, for 24 years, against their income. But it was, primarily, set up for the purchase of investment properties. For example, as mentioned, it affords the protection of limited liability, but if negatively geared, a shareholder can write off the losses against personal income. How this basically works is that negative gearing is a practice where an investor borrows money to buy a property, which is an investment property, and expects the gross income generated by that investment, at least in the short term, to be less than the cost of owning the property. So they are making a loss—they can write it off against their income—but then when they sell it and make a capital gain, they pay no tax on that. So it was primarily set up for this.

Mr Assistant Speaker, you may ask why I am talking about this. The reason I am is that a very decent chunk of this bill is reviewing and changing the look-through company tax regime. What happened in Budget 2010—[Interruption] It is a fair question. It proposed to change the qualifying company regime with a look-through company—very similar. Whereas qualifying companies were taxed like a partnership, with corporate form, shareholders were taxed at the personal rate and not at 28 percent of the company rate. Capital gains were tax free, and shareholders could access losses. But there was opposition to those who wanted an even better deal. These were the guys who could afford the tax lawyers who understood aggressive tax planning. What they wanted was a company tax rate and access to tax-free capital gains. The result of this was the look-through company regime. But they kept their existing qualifying companies—i.e. you could not start a new qualifying company, but if a qualifying company existed, you did not have to fold it and replace it with a look-through company. What the Government did promise in December 2010 was a review of the system and what this bill is is the result of that review.

What is a look-through company? A look-through company is a company that elects—so it has to be elected by the shareholders—to be treated as transparent for income tax purposes. It is like a partnership. It does not pay income tax in its own right, rather its income and expenses flow through to shareholders and are taxed at its marginal tax rates, and losses can be offset against other income. There are many advantages of a look-through company. What I am very interested in, and what we will be looking at very, very closely in the review of this legislation and the review of the look-through company regime, is to make sure that investors are actually paying their fair share. What this bill does not do is legislate for tax-free capital gains, which, in effect, is what they are. There is something called a tainted capital gain, and I will not go into the detail of that because I have probably got only about 30 seconds left. But what we are saying is that we are going to take out the tainted capital gain and it will apply only to asset sales between companies that have at least 85 percent common ownership.

I guess what I am saying is that this bill does deliver on the promised review of the look-through company regime, but what it does not deal with is the capital gains tax issue. So what is happening is that investors can still get tax-free capital gains on assets if they invest in them, and buy them and sell them through the look-through company, without having to liquidate that company. I do not think that is particularly equitable when the vast majority of good, hard-working—or middle—New Zealanders are actually paying tax on every single cent they earn. You invest in a look-through company, you earn capital gains, and no tax is paid on that. So this is why I am looking forward to this. I am looking forward to hearing what the submitters say, and I am certainly looking forward to hearing what the Inland Revenue Department says on this rather important issue. Thank you very much.

It is a pleasure to speak on this taxation bill, another taxation bill for our very fine committee, the Finance and Expenditure Committee, and I would like to thank the Minister of Revenue for his introduction to this bill. The last speaker who spoke on it, Stuart Nash, gave us a bit of an introduction into closely held companies and look-through companies and other parts of the tax system, and the main thing that the last member talked about was a capital gains tax and the inability he sees so far in this regime for capital gains taxes to follow through—

💬 Fletcher Tabuteau: Too late, you’ve already got one.

—to the shareholders. I will come to the other party that is yelling out in a minute. When we look at that, in New Zealand we do have a capital gains tax in the sense that if you sell with the intention—or if a company sells with the intention—within 10 years, then it is taxable; and it does work. Many people find that they are taxable under that regime. In fact, we have actually clarified that so that, effectively, there is no choice within 2 years, because it is deemed to be taxable regardless of intention, because of that time frame. So what Mr—the last speaker was talking about—

💬 Stuart Nash: Nash. Short-term memory.

Whatever his name may have been, from Napier—Mr Nash—is that he wants a capital gains tax, obviously. And that is the clear message, because to change the policy would involve having a capital gains tax. We have heard that time after time from the Opposition spokesperson on tax. We see this in this House every time we have a tax bill—they say: “We want a capital gains tax.” We stand up on this side and tell the public what they have just said, and then they deny it. They deny, deny, deny. Just accept that you want a capital gains tax—that it is a policy of the Labour Party. Just be honest with the public of New Zealand. Go out there and tell them that the Labour Party intends to bring in a capital gains tax. [Interruption] And now we are getting interruptions from the despicable party in this House—after the speech of their leader this afternoon. That was a disgrace to this Parliament, and we all know that. We do not need members like that in this Parliament representing—

The ASSISTANT SPEAKER (Hon Trevor Mallard): Order!

Thank you, Mr Assistant Speaker. It is good to hear that those members over there are going to be quiet now.

This tax bill is important, and it brings about four parts that the Minister talked about. The first is around the look-through companies, and we look forward to that debate going through the select committee and to the Labour Party’s intention of bringing capital gains taxes into that section of it. The second suite of measures is around the interest earned by foreign lenders. That is another part of our tax system that just needs a little bit of tightening up. And there will be changes to the non-resident withholding tax rules, changes to the approved issuer levy registration process, and correcting anomalies relating to branch structures. So that is the second part of the legislation. The third part has various amendments around GST rules. And the fourth part looks at some, mainly technical, amendments to our tax system. The other part of this legislation is that it actually brings in the tax rates for the 2016-17 income tax year. So that is important as well.

So this bill is an important part of the tax process, of making sure that we have strong legislation there. This is an ongoing process—that is, continuous legislation; it is not a one-off piece of legislation, and it really highlights the difference between the parties, and the Labour Party’s intention to bring in a capital gains tax at its earliest convenience. Thank you.

There we go—that was Hamilton’s finest export in the House tonight. They want to export—

💬 David Bennett: I raise a point of order, Mr Speaker. Stephen Donald would actually be the greatest export.

You see, the point is that Hamilton still wants Stephen Donald; he is there tonight, doing very well. David Bennett is here because Hamilton wanted to export him. They wanted him out; they did not want him there. If David Bennett had actually even been in Hamilton tonight, I suspect that the Chiefs would have lost. But he was here—thank God—and the Chiefs managed to win. So the benefit of Mr Bennett’s deep understanding of tax law in New Zealand has shone through tonight.

Debate interrupted.

The House adjourned at 10 p.m.