KEY POINTS:
Given the recessionary context where cash is king, a number of rough edges in our tax rules scream out for reform to help alleviate the cash flow concerns of many businesses.
Evidence of this concern is in the latest analysis of payment terms. They show that businesses are under increasing cash flow pressure to pay creditors, taking an average of 46.2 days to pay bills in the three months to September, more than two weeks longer than the standard 30-day term. Predictably, small and medium businesses are the worst affected taking 50.1 days to settle their accounts - 5.7 days longer than in the September 2007 quarter.
So credit to David Skilling (New Zealand Institute) and Mark Weldon (NZX) for continuing to encourage debate with the November release of the second draft of their economic strategy, Economy on the Edge: Swan Dive or Belly Flop.
In terms of ideas for potential tax reform which are neither as expensive - nor as headline-grabbing - as some of those proposed by Skilling and Weldon, we reflect on the following:
Provisional tax: The uplift basis for the estimation of provisional tax should be removed or amended to reflect the fact that profits are likely to be flat or declining. Provisional tax liabilities assume profits have increased by either 5 per cent or 10 per cent of the previous year's tax liabilities. The Government should remove this uplift and allow a business to simply pay provisional tax without any uplift.
Use of money interest: Yes, this old chestnut. If provisional tax is underpaid businesses are exposed to a 14.24 per cent interest charge backdated to their first provisional tax date. This can only be described as usury, given the economic environment where interest rates are in freefall. Many businesses are forced to overpay tax to avoid this high interest charge: this has the impact of reducing liquidity and the ability to re-invest. The entire use of money interest rate regime is flawed in that it is benchmarked to unsecured lending rates from a bank, well in excess of the normal funding rates for many businesses.
GST: Many customers will be slow to pay suppliers. As this occurs, most suppliers will have to pay the GST on unpaid invoices before they actually receive the cash from their customers. To alleviate this potential cash flow difficulty, the Government should extend the rules allowing businesses to account for GST on a cash basis. This will mean GST liabilities match cash flow.
Bad debts: Income tax deductions for bad debts are only allowed when the debt is actually written off. Many businesses will not know at year-end whether all their debtors will be collectable, but unless they actually write off those debtors (not just provide that some may not be recovered) they will be paying tax on that income as if they are fully recoverable. Relief should be provided for any amounts outstanding at balance date that become bad within six months of the business year-end. It is totally illusory for business to be paying tax on income that is never received.
Holiday pay deductions: Businesses will be searching for all available income tax deductions to ensure they are not overpaying tax. Deductions are only allowed for holiday pay accruals if the holiday pay is paid within 63 days of the business year-end. There is no logic for this limitation, other than the Government obtaining funding from all businesses that have employees. This free funding should be removed.
Depreciation rates: While it would be fiscally prohibitive to allow 100 per cent upfront deductions for capital expenditure, we believe that given the current economic crisis, depreciation rates should be revised. This would see the rates increase to reflect the drop in asset values.
Shareholder continuity rules: They currently require 49 per cent shareholder continuity to enable companies to carry forward their tax losses. In appropriate circumstances they should be relaxed to better facilitate the introduction of new equity.
Taxation on dividends: To provide more confidence for those investing in widely held equities, the Government should cap the tax payable on dividends from these entities to 30 per cent. This is consistent with the tax treatment for those shareholders who invest via portfolio tax rate entities (PIEs) and who currently enjoy a maximum tax rate of 30 per cent.
The above measures do no more than address some current "rubs" in the tax system with the aim of either improving business confidence or addressing certain cash flow constraints. They are not the total solution or an exhaustive list of what could be done to alleviate the current situation. The ideas here are simply an indication of a number of micro-tax matters that can be refined in order to make sure they are going the right way.
There is no silver bullet and certainly if there was, it wouldn't be one with tax engraved on it. But opting for a "do nothing" option does not resonate as the right thing to do in the current circumstances.
* Thomas Pippos (managing partner) and Mike Shaw (senior partner) are in the tax practice at Deloitte.
