Diana Clement: Taxman to stop people minimising wealth

People need to plan for the fact that the goalposts are being moved. Photo / Greg Bowker

Come Friday the tax goalposts are shifting. The changes are likely to affect many readers' back pockets - especially those who minimise their income on paper with the help of clever accountants.

The new rules affect property investors, business owners, trust settlors, students and anyone who gifts money or qualifies for Working for Families tax credits.

The modifications to the Income Tax Act are part of the second stage of the Government's Budget 2010 tax package that included tax cuts and a GST increase. There will also be some post-Budget tweaks made to tax laws.

One of the biggest changes is to Working for Families and is intended to counter people structuring their affairs to inflate their entitlements.

Under the new rules a wider range of income will be assessed before tax credits are handed out. It stops middle and higher income families sheltering money in trusts or giving it to their children, for example, to qualify for tax credits. The new forms of income to be assessed are:

* PIE (portfolio investment entity) income from "unlocked" sources such as unit trusts. Until now income from PIEs hasn't been counted for Working for Families. It now will be. "Locked" PIEs such as KiwiSaver and superannuation schemes are not included.

* Fringe benefits such as cars for private use, low-interest employee loans and contributions to sickness, accident or death funds.

* Children's income from investments, rent, and PIEs.

* Income of a trust that hasn't been distributed to beneficiaries will be viewed as the settlors' income when it comes to Working for Families.

* Income of a non-resident spouse.

* Private superannuation and annuity payments from life insurance policies.

* Other payments, such as regular contributions from grandparents for school fees or family living.

Taxpayers who have any of these sources of income need to let the IRD know or they will be paid too much, which will come to light when they file their tax returns.

The same rules will apply to people looking to apply for Community Service Cards and Student Allowances.

The changes could cost some families thousands of dollars a year in lost tax credits - which of course some would argue they shouldn't be getting anyway.

Another change to the Income Tax Act regarding Working for Families that will catch some readers is that investment losses such as rental losses are now excluded from the calculation of family income for Working for Families tax credit purposes.

What's more, another measure from April 1 that is designed to reduce the amount of Working for Families paid to higher earners is the removal of automatic consumer price index increases to thresholds - meaning that the thresholds no longer creeps up every year. The old system of automatic increases benefited higher earners, but not taxpayers.

Property investors who previously claimed Working for Families by making paper losses will be hit two-fold.

First of all the loss made by the property investment will be ignored for their WFF calculation. On top of that Budget 2010 removed depreciation deductions for most buildings from the start of the 2011-12 income year. If the building is designed to last less than 50 years they can still claim depreciation. There were also post-Budget tweaks that allow depreciation on commercial and industrial fit-out.

The effect of removing the ability to claim depreciation on most residential investment properties is that an investor's paper loss once claimed against income tax has been reduced or disappeared.

That, combined with lower interest rates, mean many investors no longer have "losses" to claim against other income, says Colin De Freyne, a partner at Grant Thornton.

Some will be able to take this on the chin. Others will suffer financially because they were financially dependent on claiming the losses.

It really is time for investment property owners to seek professional advice if they haven't already. As well as the various tax changes, rules relating to the ownership of their properties have been modified and if they don't act now they could be worse off tax-wise.

The loss attributing qualifying company LAQC will cease to exist from April 1. This means that property owners can no longer deduct losses from properties at their marginal tax rate and pay tax on profits at the lower company rate.

Anyone who hasn't made a decision will have the ownership structure shifted to a qualifying company (QC) by default. Owners with QCs won't be able to claim paper losses from the property against tax on their personal income at all. There are some better options, but none as juicy as the LAQC, if you're making a loss on the property in the hope of being compensated over the long run by capital gains.

De Freyne says in many cases owners would be better off moving their properties to a "look through company" (LTC), which allows losses (which are calculated differently to LAQCs) to be passed through to personal income. A useful IRD fact sheet on the changes can be found at http://tinyurl.com/6yc86oj.

Many readers of this column will be self-employed or small/medium business owners who will benefit from the lowering of the company tax rate from 30 per cent to 28 per cent from Friday. This change will benefit companies that want to accumulate profits rather than pay out to shareholders. Once a profit is paid out, says De Freyne, the shareholder will have to pay tax on it at his or her marginal rate anyway.

One group of business owners that won't benefit are those whose company derives income from one customer only. Then the company's income has to be "attributed" to the shareholders and tax paid at their marginal rate.

The Government has also indicated there will be an increase in IRD audit and compliance activity from April 1, which will no doubt catch many red-handed at tax evasion.

Taxpayers who think they have got away with tax evasion can find themselves facing the music many years later. For example, Wellington man Lance Christopher James was sentence to two years in prison last April for tax evasion of $356,000, which occurred over a 10-year period from 1998 to 2008. James had been self-employed as a company director for a number of property development companies since 1993.

De Freyne says the IRD's ability to detect fraud is very sophisticated. For example, fraud investigators are tracing transactions on overseas credit cards registered to New Zealand addresses and used here. By doing so they can identify taxpayers with overseas income that may not have been declared here.

Having said that, a few payments here and there on a foreign credit card are unlikely to be noticed. The IRD tends to be looking for amounts of $10,000 or more.

The tax rules relating to overseas income and investments are very complex and catch out a lot of individuals. Last month the IRD published a list of individuals' 10 biggest tax misconceptions relating to foreign investments and foreign income, which can be found at http://tinyurl.com/6kuzvx3.

The other big change this year is to gift duty, which will be abolished from October 1. When the change comes it will take a weight of paperwork off many people's shoulders. "Every year everyone spends hours and hours filling in gifting forms. They have to send them to the IRD to be approved and it is a pain in the backside," says De Freyne.

The change, signalled in last year's Budget, came as a surprise to many. In part, gift duty was dumped because of the huge cost of preparing the paperwork.

Removing gift duty could result in taxpayers using gifting to defeat creditors or qualify for social assistance such as rest home subsidies, Working for Families and Student Allowances. IRD policy group manager Craig Latham said in December that this would be monitored closely and changes made to the law if necessary. Although gift duty prevented such abuses, it was incidental and not the reason for it existing.