Are you ready for the new withholding tax rules?
Tax Alert - April 2017
Emma Marr and Liv Thomson
New withholding tax rules apply from 1 April 2017 that will allow contractors to elect their own withholding rate. Further, the withholding tax rules are extended to labour-hire firms. There is a fish-hook in the rules for some contractors who operate via a company and are working for a labour-hire firm, so some quick action will be needed to get the right tax outcome.
The rules apply to payments made to such contractors from 1 April 2017, regardless of when the services relating to the payment were performed. Although in the case of expansion of the rules to labour-hire firms, up to a 3-month extension may apply in order to get compliance systems in place.
The standard withholding rate is 20%, if the contractor is working through a labour-hire firm, or if there is a particular schedular rate set out in legislation, then this rate will apply (these are the old rates that apply to contractors such as entertainers, labourers, farm workers and so on). Contractors have the option to elect their own rate by completing an IR330C. The minimum withholding rate that can be elected is 10%, or 15% for non-residents or contractors with a temporary work visa. However, some resident contractors may be able to obtain a lower withholding rate – as low as 0% – by applying for a special tax rate certificate from the Commissioner of Inland Revenue. This will be particularly important for contractors operating through a company where they are subject to the income attribution rules or who have a look-through company, and this is covered in more detail below.
If the contractor fails to provide their name and IRD number to the payer a non-declaration withholding rate of 45% will apply (20% for a non-resident company). Contractors can’t regularly change their withholding rate – more than two changes in a 12-month period will require the consent of the payer. In addition, the Commissioner has the ability to prescribe a withholding rate (no higher than 60%) where the contractor has a tax debt.
The contractor withholding rules will now also apply to payments made by labour-hire firms. A labour-hire firm is one for which labour-hire arrangements are one of the main activities of the firm. These types of arrangements involve a client hiring a firm to provide a contractor to perform work or services for that client. The client then pays the firm, who in turn pays the contractor. Such firms must, if their systems are capable, start deducting withholding tax from payments made to contractors from 1 April 2017, but have until 1 July 2017 to get their systems in order if necessary. These rules will apply whether the contractor works through a company or on their own account.
Potential issues for contractors
Credit transfer issues may arise for contractors operating through a company. If the personal attribution rules apply (meaning the income is attributed to the shareholder of the company) or the company is a look-through company, withholding tax credits deducted by the labour-hire firm are useable by the company rather than the individual contractor. The tax credits could be refundable once the company files its annual income tax return, but this obviously creates a timing issue as the individual contractor will not be able to access the tax credits to cover their personal income tax liability (including provisional tax obligations) until the company’s return is lodged and assessed (after the end of the income tax year).
As a result, the individual contractor will still have to pay provisional tax, even where withholding tax is deducted from the payments made to their company. The contractor can estimate their provisional tax to take the withholding tax into account, but this means they miss out on the new use of money interest concession rules now available under the simplified provisional tax rules, because this concession is only available if the standard uplift method is used for at least the first and second provisional tax instalments.
There are two options currently available to contractors who are subject to the personal attribution rules or have a look-through company when receiving payments from labour-hire firms with withholding tax deducted:
- Apply for a special tax rate certificate of 0% for the company by filing an IR23BS with Inland Revenue
If a special tax rate certificate of 0% is issued by Inland Revenue and is presented to a labour-hire firm, the labour-hire firm will not be required to withhold tax from payments made to a company. The contractor may still have to pay provisional tax, and has increased administrative requirements as a special tax code application must be lodged annually to renew the 0% rate.
While it may have been difficult to obtain 0% special tax rates in the past, Inland Revenue has advised us that it is happy to issue 0% tax rate to a company subject to withholding under a labour-hire arrangement, provided the taxpayer has a good record of filing returns and making payments on time.
This is because Inland Revenue will still be receiving details of the gross payments made to the company by the labour-hire firm and will be able to check gross income recorded against the company’s income tax return if desired.
- Transfer the credit after year end
The current rules allow a transfer of credits between associated taxpayers for tax withheld or deducted on the taxpayer’s behalf. The transfer is deemed to take place on the day after the end of the accounting year for standard or late balance dates or 1 April following the balance date for early balance dates.
This means that for contractors with a 31 March balance date the effective transfer date will be 1 April of the following income tax year, which falls after the first and second provisional tax dates (28 August and 15 January, respectively).
Any refund of the company transferred to the contractor on 1 April could be applied against the third instalment of the individual’s provisional tax due on 7 May, but this doesn’t solve the problem of the first two provisional tax instalments.
A change to the credit transfer rules would be a useful solution, perhaps by allowing for transfers of withholding tax credits from a company to individual contractors who are subject to the personal attribution or look-through company rules effective on the date of withholding. Contractors operating via a company are advised to consider whether they should apply for a special rate certificate and, if so, to apply sooner rather than later.
April 2017 Tax Alert contents