KEY POINTS:
Michael Cullen once said Labour was "philosophically opposed" to tax cuts. However, the Government's pruning of the company tax rate from 33c to 30c shows it is taking a slightly more pragmatic approach to business tax. The company tax cut is one of a swag of recent changes to tax rules. While a cynic might note that it is election year after all, most of the changes are aimed at encouraging savings and investment, and boosting the local economy.
The changes include a tax break for research and development, the imminent cut in the company tax rate, special investment incentives for KiwiSavers, and an overhaul of how overseas investments are taxed. They also include the introduction of limited partnerships, making investment in New Zealand more attractive for venture capitalists.
Business attitudes towards tax have changed over the past two decades. Enthusiasm for aggressive tax avoidance schemes, rife in the 1980s and early 1990s, has been dampened by tougher penalties.
Back then, the courts were more relaxed about tax avoidance, says Grant Sidnam, a tax partner at Auckland law firm Hesketh Henry.
The introduction of the penalties regime in 1997 hasn't stopped all taxpayers from pushing the boundaries, he says, but it has deterred some.
More recently, there has been an attempt to create a level playing field for all taxpayers, says KPMG tax partner Murray Sarelius.
The trend is towards a broad base, low rate tax system that does not deliver incentives for particular economic activities, he says, and towards tax neutrality in business and investment decisions.
The recent KiwiSaver and R&D tax credit reforms pull against this trend by providing incentives to save and for R&D activities.
So do all the recent changes make dealing with tax any easier? Sarelius doesn't think so - yet.
The drive toward tax neutrality has sometimes been achieved at the cost of simplicity in the tax laws, he says, making them unnecessarily complicated, particularly for individuals with investments. The recent reforms are "generally welcome", but simplification is still needed.
Here are some of the key changes - soon to come, or recently introduced.
R&D TAX CREDIT
What is it?
A 15 per cent tax break for companies that spend more than $20,000 a year in New Zealand on research and development.
Who is affected?
Allowing companies to claim 15c for every dollar they spend on R&D is an attempt to encourage local firms to keep such work in New Zealand and to entice overseas companies to do their R&D in this country. Start-up companies will be able to benefit because the credit will be paid out in cash to loss-making businesses - which most start-ups are in their early years.
What are the issues?
Identifying what R&D projects, and on what R&D spending, a business can claim will be the biggest hurdle, says Deloitte national R&D incentive leader Aaron Thorn. Inland Revenue has released draft guidelines showing it will require "quite intensive documentation" from businesses wishing to claim, he says.
Firms whose R&D is focused on developing new products should find it relatively easy to identify their R&D spending, but manufacturers, whose R&D generally focuses on improving processes, "will find it more difficult", says Thorn.
What he means is that claiming a rebate on R&D that was involved in a commercial operation at the same time as it was being tested could prove awkward.
It's useful to compare New Zealand's R&D credit regime to Australia's. Across the Tasman, companies receive an effective 7.5 per cent rebate on their R&D.
Thorn, a former R&D tax partner for Deloitte Australia, says that while New Zealand's 15 per cent credit is more favourable than Australia's, claiming the credit will require a careful approach because the guidelines on what can be claimed are tighter than they are in Australia.
Businesses can claim on "supporting" R&D activities in New Zealand only if their "main" purpose was R&D. This makes R&D difficult to claim if it was done while completing a customer order or during production trials, says Thorn. In Australia, companies can claim those types of "supporting" R&D expenditure, but only if they can show they were necessary to deliver the R&D.
Australia's inclusion of supporting expenditure has led to claims for some hefty amounts by banks and mining companies, says Thorn, something New Zealand has obviously tried to avoid.
New Zealand's allowance for software development compares favourably with the Australian rules. Companies can claim on software intended for sale, and up to $3 million of software developed for their own use, such as a plant automation system. In Australia, companies can claim on software developed for sale, but only in certain cases can they claim on software developed for their own use.
However, while the $3 million cap may be enough for start-ups and smaller to medium-sized companies, it's a drop in the ocean for large companies, especially heavy software developers such as banks and telecommunications companies. These big spenders feel they've been overlooked, and want to see the $3 million cap raised.
The Finance Minister can approve higher amounts in individual cases, says Thorn, but that is only likely to happen in exceptional situations.
Last year, the cap was raised from $2 million to $3 million and the Government has promised to review it.
Thorn would like to see the cap raised, or removed.
"Software is such a big part of the future - if New Zealand is trying to become a knowledge-based economy, why cap the rebate on it?"
The IRD's cautious approach to the regime is due to the number of "unknowns", says Ernst & Young tax director Colin de Freyne.
There will be some industries that the IRD sees as riskier than others, and it will scrutinise claims from them more closely, he says.
Also, companies don't know whether they're going to be investigated by the IRD and have their claim reduced.
"Will the thought of investigation put any firms off claiming what they're entitled to?"
Businesses involved in joint R&D ventures should check that their contracts are clear on who owns the research, and who carries the financial risk, he says. State-governed organisations, such as Crown Research Institutes, health organisations and tertiary institutes, are not eligible for the tax credit, so companies cannot claim the credit on joint R&D ventures with them.
The R&D credit was introduced as part of the Taxation (Business Taxation and Remedial Matters) Act 2007 in October, and comes into effect in the 2008-09 income year.
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LIMITED PARTNERSHIPS
What is it?
A new business structure aimed at giving start-ups better access to venture capital, and an update of the tax rules applying to general partnerships.
Who is affected?
Mostly businesses and new ventures looking to attract overseas funding. The tax changes will affect anyone who operates part of their business as a partnership, such as accounting and law firms, because it especially relates to partners leaving the partnership.
What are the issues?
Instead of being taxed at the partnership level, limited partners will be taxed at their relevant tax rate, in proportion to their share of the partnership's income. Because losses and profits flow straight through to the partners, a limited partnership can be more tax-effective than a company if the venture makes early losses - the case with many companies involved in biotech and other R&D-heavy industries. A limited partner's tax losses will be restricted to their economic loss in that year.
Limited partners are liable only for the amount of money they put into the partnership - unlike general partnerships, where all partners are liable for all debts.
The general partner runs the partnership, makes investment decisions and has unlimited liability for the partnership's debts.
The regime effectively prohibits a limited partner from taking part in the management of the business of a limited partnership. However, because most venture capitalists take a seat on the board of start-ups they invest in, the new structure allows a "safe harbour" where limited partners can have some say in how the partnership is run, without losing their limited liability status.
The changes have brought New Zealand into line with internationally accepted models, says Deloitte tax partner Bruce Wallace.
Limited partnerships are a common vehicle for international investment, especially for private equity and venture capital funds, he says, and New Zealand was potentially putting off prospective investors not having the limited partnership regime.
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COMPANY TAX RATE
What is it?
A tax cut for companies, starting in the 2008-09 tax year. They'll pay 30c tax in every dollar instead of 33c. New Zealand's company tax rate has been 33c since 1989, when the Labour Government cut it from 48c, and was one of the lowest in the OECD from 1990 to the early 2000s. However, while New Zealand's rate has remained the same, the average company tax rates for the OECD and the EU have fallen steadily since 1999.
Who is affected?
All companies. It's an automatic change, so nothing needs to be done to qualify, but sole traders or partnerships may want to calculate the benefits of becoming a company instead. In theory at least, the rate cut aims to help increase New Zealand's productivity. Investors in companies get more after tax, so are encouraged to invest more, and companies gain from the extra investment.
Companies should pay attention to the timing of any large transactions they have planned, says Ernst & Young executive director of tax, Aaron Quintal.
For example, a company aiming to make a large sale should try to push it back to the 2008-09 year to take advantage of the lower rate. The buyer, however, would want the sale contract signed during the 2007-08 year at the higher rate.
Timing is also important for companies that offer imputation credits, says Quintal.
Companies have until March 31, 2010 to distribute imputation credits under the (old) ratio of 33:67. This allows individuals, who haven't been given a tax cut, to take advantage of the 33 per cent rate from those imputation credits. However, shareholders who are companies or non-residents don't particularly value imputation credits, and would be happy at the new 30 per cent level.
"It's just a matter of companies examining who their shareholders are, and whether they need to distribute their imputation credits early or not," Quintal says.
There has been a huge increase in the number of people earning exactly $60,000 in salary, with the rest presumably sheltered in a trust or company to avoid the top rate, Quintal says.
There has also been an "astronomical" growth in the amount of income earned through trusts in recent years.
However, the Government has hinted at raising the tax rate on income earned through a trust to counter that growth, and that, combined with the lower company tax rate, may see the popularity of trusts wane, Quintal says.
Income earned through a trust is taxed at a maximum of 33 per cent, no matter what a beneficiary's personal tax rate is. Trusts are also more flexible than companies about where and to whom earnings can be distributed.
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PIEs
What is it?
As well as setting up KiwiSaver, the Government has tried to make investing in financial assets easier and more attractive, and to broaden the country's investment horizons beyond property. It introduced portfolio investment entities (PIEs), managed funds which allow investors to be taxed at their own personal tax rate on any income from the fund.
The changes help level the investment playing field: investors who pay personal tax at the lowest rate of 19.5c will have their PIE income taxed at the same rate, providing their income (PIE and salary) is below $60,000 and their taxable income - excluding PIE income - is less than $38,000.
Investors who pay tax at the higher rates of 33c and 39c will be taxed at 33 per cent until April 1 this year, when the tax level drops to 30 per cent.
Before PIEs, all investors would have paid tax at the managed fund's rate of 33c. The new system also means investors on relatively low incomes, like retirees, won't be pushed into the next tax bracket by their PIE income.
Another advantage is that PIEs that invest in New Zealand and most Australian listed companies are not taxed on their capital gains when they sell shares, bringing the PIEs' treatment into line with individuals who invest directly in those New Zealand and Australian shares.
Previously, many managed funds were taxed on capital gains, which reduced investors' returns.
Investments in countries outside New Zealand and most Australian listed companies will be subject to the Fair Dividend Rate, under which 5 per cent of the value of the overseas investments - as of April 1 each year - will be taxed. However, under that system, individual investors whose offshore investments don't perform well and yield less than 5 per cent are able to pay tax only on the actual return; other investors, including family trusts, are taxed on 5 per cent no matter what.
Who is affected?
All investors, including people investing directly in overseas shares or in offshore managed funds, and also those who have invested directly in New Zealand shares.
This is a significant change for the managed funds industry. Investors have become used to doing things the same way, but should take a fresh look at how they are investing in light of the new regime, says PWC tax partner Paul Mersi.
"The ground has changed even for people who haven't invested in managed funds. The reason they might have preferred investing in a particular way before may change because of PIE regime. I'm not saying they should all change and invest in New Zealand managed funds, but they should have another think about it."
Long-term, he says, this regime, combined with KiwiSaver, should help New Zealand create a war chest of savings in financial assets, not just property, which should in turn help boost the economy.
And, as more people invest, hopefully financial literacy will increase too.
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FAIR DIVIDEND RATE
What is it?
A new method of calculating returns on overseas investments. The FDR reforms were introduced as part of a package encompassing changes to taxation of New Zealand managed funds, and KiwiSaver.
These rules came into effect from the 2007-08 income year - April 1, 2007 for individuals.
Who is affected?
Investors who own overseas shares, if their holding is less than 10 per cent of the company. This applies to companies and pooled investment vehicles, as well as to individuals and family trusts. Individuals may be excluded from these rules if their total investment in overseas shares taxed in this way has a cost of $50,000 or less.
The FDR reforms represent a significant change in the way taxable income is calculated, says KPMG tax partner Murray Sarelius. When the market is positive, most investors will see the benefit of paying tax only on a 5 per cent return, but they need to be aware that the lack of deductible losses will mean tax will no longer dampen the effect of a falling market.
The intention of this package was to lessen the impact that tax has on investment decisions, Sarelius says.
The reforms have achieved this, for example by removing the distinction between investing in the old "grey list" countries (where New Zealand investors enjoyed a relatively benign tax treatment) and emerging markets, but tax still remains a relevant consideration for investors.
Another reform involves Controlled Foreign Companies (CFCs) - investments where five or fewer New Zealanders control an overseas company. Businesses with offshore subsidiaries will be affected most.
The CFC-related reform proposes removing the grey list, meaning there is no difference between investing in one country or another. The list will be replaced by an active/passive business test to exempt active businesses from the CFC rules, which require New Zealand shareholders to return income earned by the CFC, even if it is not paid to them as a dividend.
Instead, the shareholders of a company that is excluded from the CFC rules will pay tax on dividends as they are received. Companies that earn less than 5 per cent passive income will be treated as active businesses and will not be subject to the CFC rules, no matter where they do business.
Passive income is likely to include royalties, dividends, interest and in some cases, rent.
The reforms are good news for companies with active business subsidiaries outside the grey list countries, but those with passive income subsidiaries in the current grey list countries will be disadvantaged as they become subject to the CFC rules, says Sarelius.
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CHARITABLE DONATIONS
What is it?
From April next year, the $1890 cap on rebates for charitable donations will be removed. Donations of any amount - up to an individual's total net income - will be eligible for a 33.3 per cent rebate.
Who's affected?
People making donations over $1890 will be better off under the proposal.
