Thomas Pippos: Tax needs bold change, not tinkering

With just over a week to go until the Budget is handed down next Thursday, the business community is eagerly waiting to see what a recently promised $1 billion package of tax breaks will mean for them.

At a recent speech to the International Fiscal Association, Michael Cullen unveiled a series of tax changes worth more than $230 million designed to simplify tax and reduce business compliance costs.

These changes, coupled with those expected on or by Budget day, will comprise a multitude of matters - ranging from what could be classed as long-overdue remedial matters to substantive policy decisions.

The more interesting ones foreshadowed include:

* Fringe Benefit Tax: The shelving of a plan to extend the rules to include car parks provided by employers in the CBDs of major cities; the use of book value of a car rather than cost to calculate the tax and, importantly, through various exemptions, excluding small fringe benefits and small businesses from the rules.

* Limited partnerships: A revamping of outdated special partnership rules, targeted at facilitating venture capital activities.

* Tax simplification: Aligning provisional tax and GST.

* Foreign investment vehicles: Changes that help to attract wealthy individuals into New Zealand.

The question now hanging over business is where the rest of the $1 billion comes from.

Final details are being kept under wraps until May 19, although Cullen has indicated that the bigger-ticket tax items to expect in the Budget relate to depreciation and changes to encourage more investment and saving.

Depreciation

One of the Government's concerns about the tax depreciation system is that present economic depreciation rates may not accurately reflect the reality of economic life in a time of rapidly advancing technology.

If they do not, they may have a disincentive effect on the level of capital investment and may be biased in favour of long-term investments such as rental housing and against short-term assets such as high-tech machinery.

What we can probably expect in the Budget are announcements of increased depreciation rates for shorter-lived assets, with companies investing in new technology potentially having the most to gain.

It is also hoped that the Government will lift the $200 threshold at which assets can be immediately written off rather than capitalised for tax purposes; a realistic threshold would be, say, $1000.

There has also been public discussion about tightening up and potentially reducing depreciation charges applicable on rental properties. Clearly, this move would not be welcomed by the many rental property investors out there if it proceeds.

Savings and investment

This Government has long expressed a commitment to developing policies that build the asset base and savings capacity of New Zealanders. As far as tax is concerned, areas that are expected to be addressed in the Budget include work-based savings and dealing with the problems inherent in the taxation of investments.

As far as work-based savings are concerned, any form of encouragement for employees to participate in superannuation schemes is a worthwhile change.

In relation to the taxation of investments, the Government is expected to announce some decisions addressing the issues raised last year in a report it commissioned from former BT Funds Management chief executive Craig Stobo.

The issues it raised include the different treatment of: investment gains in collective investment vehicles; income from offshore investments as opposed to income from New Zealand investments; and investments in shares from Australia, Britain, Canada, Norway, the United States, Germany and Japan.

Similarly, differences in an individual's marginal tax rate and the tax charged on income derived from collective investment vehicles.

It would also not be surprising if some related issues are kicked back into consultative touch, given what appears to be the inability to find a solution on which all interested parties can reach some form of consensus.

I would go as far as to be shocked if we achieved finality. The challenge in this area is coming up with a workable solution to deal with the many problems inherent in taxation of income from offshore investments.

The carbon tax

Last week, the Government said the carbon tax would be set at $15 per tonne and introduced in April 2007. This will add about 1c to the cost of a unit of electricity, about 4c to a litre of petrol, 46c to a 9kg bottle of LPG and 68c to a 20kg bag of coal. The changes will cost the typical Kiwi household about $4 a week.

A nice spin is that carbon tax is not expected to raise revenue but instead will be recycled by the changes in the tax system expected to be announced by Cullen in the Budget.

In short, but for the carbon tax the Government would not have been able to be so generous with business tax breaks.

I would have to say I am not moved.

The vast majority of positive business changes are remedial in nature and are good policy that should be made. Like it or lump it, the carbon tax will raise real revenue that goes to the Government, not back to business. I suspect linking the two is a recent phenomenon to take some heat off that issue.

So where is all this going? Is it just tinkering around the edges or setting a new direction for New Zealand's tax policy?

Despite the expected winners in the Budget, few people accept the level of tax charged in New Zealand is optimal and generally more than tinkering is required.

Cullen seems also to be ignoring the latest surveys indicating that two-thirds of people feel they are paying too much tax. The lack of any moves to adjust tax brackets for inflation has compounded the problems, with many middle New Zealanders (four out of every 10 policemen and one in every four secondary school teachers) now paying the top marginal tax rate.

Many business leaders still refuse to believe the tax levels benefit business growth and are increasingly concerned that New Zealand's corporate tax rate remains high while many other countries are reducing theirs.

Despite mounting pressure, Cullen has continued to stress that he will not be cutting tax rates as he considers he can get much more bang for his buck by reforming the tax system to try to stimulate investment; also the baby boom issue is weighing heavily on his mind.

Some indication of a move in tax rates is long overdue.

As an example, in a discussion paper sent by the Dutch Finance Minister to the Dutch Parliament on April 29, there are plans to introduce a raft of ground-breaking improvements to the Dutch tax rules with a view to making the Netherlands one of the top locations for investment.

Among the measures being proposed is a reduction in the corporate income tax rate to 20 per cent for profits up to 41,000 and to 26.9 per cent for amounts in excess of that; the tax rate for profits derived from intercompany financing and treasury activities will be reduced to 10 per cent; there will be cross-border relief for losses incurred by EU subsidiaries; and an abolition of capital gains tax.

These changes will make the Dutch tax rate the second lowest in Western Europe. It's simple tax changes such as these which make the real difference: transparent, easily understood and with an immediate impact on the bottom line.

* Thomas Pippos is the managing tax partner at accounting firm Deloitte

Going Dutch

* Proposed tax changes in the Netherlands will make its tax rate the second lowest in Western Europe.
* Company tax will be cut to 20 per cent or 26.9 per cent depending on profit.
* Tax rate for profits derived from intercompany financing and treasury activities will be reduced to 10 per cent.
* There will be cross-border relief for losses incurred by EU subsidiaries.
* Capital gains tax will be abolished.