Treasury, IRD disagreed over cuts, papers reveal

Photo / Paul Estcourt

A stack of Budget advice papers released yesterday reveal an extended arm wrestle between the Treasury, which wanted a company tax rate cut, and Inland Revenue, which opposed it.

In the end, the Treasury had the brawnier bicep.

The disagreement arose partly because a number of measures to broaden the tax base were under consideration which would impact on business taxpayers.

They included denying depreciation on buildings (about 60 per cent of the impact of which is expected to fall on commercial and industrial properties), removing the accelerated depreciation of plant and machinery, and changes to the thin capitalisation rules applying to multi-nationals investing in New Zealand.

These measures were motivated at least partly by fiscal considerations, as a February 12 officials' paper makes clear.

A key issue, it said, was the extent to which the company tax take should be increased to fund personal tax rate reductions.

The Treasury was concerned that those measures would be equivalent to pushing the company tax rate back up from 30 to 33 per cent.

It favoured a lower company rate for economic reasons and worried about how much the Australians might cut their rate. It argued for a cut to 28 per cent.

"From a strategic perspective we see risks in New Zealand, as a capital-shallow investment-seeking economy, having a statutory tax rate for companies that is increasingly out of step with OECD comparators, then driving the effective tax rate even higher through base-broadening measures without offsetting tax rate reductions," it said.

The IRD, however, believed the rate should stay at 30 per cent and relief be provided by scaling back the base-broadening.

It argued that in New Zealand it is easier than it might be elsewhere for companies to earn location-specific economic rents - that is, returns greater than they need to justify their investment.

Cutting the company tax rate would just increase those rents and that would be especially gratuitous if those windfall gains flowed to foreign investors. Reducing the company tax rate, funded by less depreciation, was likely to have the perverse effect of reducing incentives to invest in New Zealand, IRD officials said. Aligning company and personal tax rates as closely as possible would enhance efficiency.

"If ministers wish to reduce the impact on companies as part of the rebalancing of the overall package, the IRD would recommend that this be accomplished by scaling back on the depreciation changes rather than reducing the company tax rate."

But the Treasury was sceptical of the economic rents argument and said concerns about the distortions arising from having a gap of 5c in the dollar between the top personal and company rates needed to be kept in perspective.

"It is less than the current 8c gap and less than the historic 6c gap between the 33c company and 39c personal tax rate," it said.

"Also, crucially, such a distortion affects how an investment is made (through a company instead of individually) and not what investment is made (for example, in real property or a debt instrument)."

The economic costs of the second kind of distortion were much greater, and would be reduced by cutting the company tax rate, it said.

The Budget's numbers on the revenue impact of the tax changes show that, even net of the cut in the company rate from 30 to 28 per cent, the base broadening measures on depreciation and thin cap are expected to increase the tax take from business by $1.4 billion over the next four years.

That assumes the Treasury is right to expect about 60 per cent of the building depreciation change will fall on commercial and industrial, rather than residential properties.

DOOR OPEN TO MINIMUM PROPERTY TAX

The Budget might not mark the full extent of the tax man's designs on landlords.

A March 31 note from officials refers to ministers' concerns that even with the tax changes in the Budget, there might still be over-investment in rental property.

The Government by that stage had ruled out a broad-based capital gains or land tax, and loss ring-fencing.

But one measure on which further work could be done beyond Budget 2010, officials said, would be to "impose a minimum tax on all rental property".

"This would involve setting an annual minimum taxable income based on a percentage [say 1 or 2 per cent] of the residential property's total value [either gross or net equity]."

Landlords would also calculate actual taxable income in the normal way and pay tax on it or the minimum taxable income, whichever was higher.

"We don't recommend it for Budget announcement."