The taxation of business

By Alex Mitchell

With regular headlines indicating lowering business confidence, the Interim Report could be considered an opportunity lost to change the direction of travel. From a business perspective, there are relatively lean pickings compared to other areas where the Tax Working Group (TWG) has focused - particularly the extensive work regarding taxes on capital. Business tax reform is an area where it is clear further work is required between now and the Final Report in February 2019. If a decision is made to extend the tax base, then that additional tax revenue should be recycled back into reducing taxes and compliance costs in productive areas of the economy.

No change to the headline tax rate

Despite the OECD average company tax rate falling to 23.9%, the TWG has concluded that there is not a sufficient case to justify a reduction in the company tax rate in New Zealand. The rate will remain at 28%. This is a disappointing outcome, as a competitive company tax rate was one of top 10 business initiatives highlighted in our Major Companies Tax Survey in 2017. The fact is, company taxes are some of the most harmful to productivity. This point was acknowledged in the recent Australian Re: think tax review, but this view hasn’t found favour with the TWG.

It’s interesting to note that the Interim Report indicates that the TWG Secretariat undertook modelling of the impact of the company tax rate and found that the impact on national income was minimal. The report notes that the modelling undertaken is open to criticism, and was in fact criticised by an independent reviewer. However, these criticisms are largely dismissed in the Interim Report, with a statement that the independent reviewer still agreed that the case for a company tax reduction is weak. As all the detailed working papers are available for review, including a more detailed summation of the independent reviewer’s remarks, we question whether this is a fair reflection of the critique received – you can read the more detailed summary of the independent review for yourself here.

The TWG has given consideration to progressive company tax rates (i.e. lower rates for smaller businesses) and also concluded that this should not be pursued.

What about compliance costs?

With the headline rate set to stay at 28%, the TWG does suggest some very modest initiatives which should have the effect of reducing compliance costs for some businesses, in particular small businesses. While it is hoped this is not a final list of all the compliance cost-reducing businesses tax reforms we can expect from the TWG, for now it is suggested that:

• The threshold for paying provisional tax is increased from $2,500 to $5,000-$10,000
• The $10,000 year-end closing stock adjustment is increased to $20,000-$30,000
• The $10,000 limit for automatic deduction of legal fees is increased, and this type of automatic deduction extended to more types of expenditure

On a positive note, the Ministers of Finance and Revenue have written to the TWG encouraging them to expand on compliance-reduction options in the final report.

Enhancing productivity

Three options for enhancing business productivity are called out in the Interim Report for further evaluation in the lead up to the final report: loss continuity rules, black hole expenditure, and building depreciation deductions. All three of these areas are long overdue for reform and we welcome them being put on the table.

Loss continuity rules – the existing loss continuity rules are particularly harsh on small start-up firms which need access to more capital to grow.  A key question will be how far any changes to the existing continuity rules extend, noting that the period of loss-making in new ventures can occur for some time, and the entities are not always “small”.

Black hole expenditure – this is business expenditure which is not currently deductible in any form. Any extension to capital income taxation may finally provide the impetus needed to comprehensively fix this issue.  However, the issues need not be linked.  A discussion document released by the previous Government sought to address issues associated with black hole expenditure, such as feasibility expenditure, even in the absence of a capital gains tax.  Continued debate on extending the taxation of capital should not stymy advancing a resolution to black hole expenditure, which potentially acts as a handbrake on innovation.

Building depreciation – depreciation was removed from buildings in 2010, but this decision is now being questioned. The TWG will further evaluate reinstating depreciation for commercial and industrial buildings as well as multi-unit residential buildings.

What do we recommend?

It would be great to see more recognition of the benefits of a thriving economy in the Final Report. A key part of that is having clear rules and regulations which support businesses and recognise the positive flow on impact this has on business confidence, employment, and business commitment to innovation and capital spending.

While we question the decision to not lower the company tax rate, if it is not possible to reduce the headline rate, consideration should be given to material changes that can be made to reduce the effective tax rate and compliance costs. Examples of this could include:

• Accelerated depreciation or higher thresholds for expensing fixed assets
• Aligning more tax and accounting treatments
• Simplifying the entertainment tax regime
• Simplifying the fringe benefit tax regime
• Simplifying the depreciation regime
• Addressing the cost and uncertainty created by blackhole expenditure
• Reducing certain reporting requirements, e.g. seeking Inland Revenue approval to change dividend imputation ratios and issuing buyer created tax invoices
• Reducing taxes and compliance costs on businesses hiring non-residents; the existing rules place high compliance costs on employers and are easy to get wrong