Diana Clement: Don't let tax returns become a nightmare

File photo / NZ Herald

Waking up in a cold sweat over the spectre of a tax audit isn't a nice thought. It really is a good idea to keep on the right side of the Inland Revenue Department (IRD).

With March 31 fast approaching, it's worth putting in some work now to minimise tax and reduce administration headaches.

The best advice, says Daniel Hunt of Daniel Hunt & Associates, is to stay organised and keep all the appropriate documentation filed. "It makes the tax return process stress-free."

Some simple steps worth taking at this time of the year include:

• Student loans: If you have cash available, you may want to consider making a lump-sum payment on your student loan before March 31 to qualify for a bonus reduction of your loan balance, says Dan Lowe, Grant Thornton New Zealand associate. "This is a 10 per cent bonus you can receive for making voluntary repayments that total $500 or more in a tax year. The bonus will generally be 10 per cent of the voluntary repayments you make, not 10 per cent of your loan balance."

• Don't make a meal of your Pies: Lowe has come across a number of people who are paying the wrong tax on their Portfolio Investment Entity (Pie) investments. "If a person has an investment in a Pie fund they need to select a prescribed investor rate (PIR)." If you have chosen a Pie rate that is too high it is not possible to get a refund from the IRD, says Lowe. If your rate is too low, however, and the IRD finds out, it will be necessary to repay the shortfall.

Lowe says he has seen examples where companies had elected a PIR rate of 28 per cent, whereas it should be 0 per cent, and trusts that were mixing and matching rates.

The IRD has an easy to follow table outlining PIR rates at: Ird.govt.nz/toii/pir/workout

• Special Tax Codes (STC): Some people who earn employment income and have other business/investment interests that generate tax losses qualify for a STC, says Lowe. If the taxpayer qualifies he or she gets a reduced rate of tax throughout the year rather than waiting for the tax return to be filed and receiving a refund at that point. A common example of this is someone who has rental property losses that he or she claims back at the end of the year. By filling in an IR23BS for the Inland Revenue and an IR330 for the employer he or she may qualify to reduce the tax rate on their PAYE earnings during the year. Both forms can be found at Ird.govt.nz/forms-guides . "As a STC is only valid for one year, new applications should be made now to take effect as close as possible to April 1, 2012," says Lowe.

There are times when an accountant is worth his or her weight in gold. Some examples of these more complex tax matters facing taxpayers include:

• Cash or accrual accounting: Investors with significant chunks of money overseas need to pay attention to whether they use a cash or accrual method of accounting. Lowe cites the example of someone with a $100,000 cash inheritance invested in Australia five years ago. Thanks in part to exchange rate changes that investment might be worth $150,000 today, which could result in an unexpected $16,000 tax liability on the unrealised gain under the financial arrangement rules. "An annual review of a person's financial arrangements should occur to determine whether they are a cash basis person or an accruals basis person. The test is cumulative so over time certain people may morph to an accruals basis which can have significant impacts."

• Foreign income: People who receive foreign income such as rents must ensure they comply with New Zealand tax law when they include information in their tax returns. Although this doesn't need to be done by March 31, it's sometimes a long and difficult process and it's a good idea to start early. Lowe says to beware of simply converting statements received from an overseas accountant. Such statements from Australia, for example, might contain depreciation on a rental property, which can't be claimed against tax here. There are a number of other pitfalls for investors. For example, those people who own foreign shares, fund investments with foreign shares in them, or overseas superannuation may need to pay tax on them whether or not they have received an income. They will need to use either the comparative value or fair dividend rate methods. In both cases they will often pay tax even if they haven't received any income.

Plenty of readers own rental properties and they add another level of complexity to the end-of-year tax planning.

• Depreciation: The big issue for many property investors this year is depreciation. They've been used to claiming depreciation on everything down to the tiles on the walls. Now that depreciation claims on investment properties have been scuppered by the IRD, investors could find that their properties are profitable on paper for the first time. Specialist property accountant Mark Withers of Withers Tsang says it's important to get your property accounts processed as soon as possible by your accountant to get advance warning of your "new normal" tax position without depreciation. "This will materially affect property owners who are used to receiving losses primarily contributed by claiming depreciation," says Withers.

• LAQCs and LTCs. The LAQC died a death last year as the means to transfer losses from rental properties to the owner's personal tax. A lot of rental property investors have stuck their heads in the sand and done nothing, which isn't really a sensible option. Those owners who fall into this category still have an opportunity to transition to Look Through Companies (LTCs) before September 30 this year, says Withers. It's too late to claim rental losses for the 2012 year, but by making changes now they'll at least be able to claim their losses against personal tax in 2013.

Withers adds that there are a number of new rules around LTCs that property investors need to be aware of. For example, there is a "loss limitation" rule that determines how much of the loss allocated to a shareholder can be claimed in that year.

The calculation is based on each owner's effective interest rather than the shareholding percentage.

Another trick is that any loss balance from an income year when a company wasn't an LTC is written off when the company becomes an LTC, so isn't deductible in the company's first income tax return as a LTC.

DIY investors might want to seek advice from an accountant this year at least to ensure they understand the ins and outs of LTCs such as the need to prove they have guaranteed LTC debts.

The IRD has a guide to LTCs, which can be found at http://tinyurl.com/lookthrough

• Repairs and maintenance: Lowe recommends doing repairs and maintenance on your investment property before the end of the financial year. "Any R&M expenditure is deductible in the year it is incurred," says Lowe. "Beware, however, that anything deemed a capital improvement can't be deducted for tax purposes thanks to the demise of depreciation."

The IRD is keen to remind taxpayers to use its online services. Services include secure email, electronic tax return filing, detailed information about your transactions and balances and the ability to update Working for Families details.

Business and personal taxes aren't mutually exclusive.

Small business owners in particular often have their business and personal financial affairs intertwined. Small business tax planning at the end of the financial year can really pay dividends when it comes to minimising personal taxes.

That's especially true where losses can be passed through to your personal tax, which they can if the company is owned in a sole name, partnership, or LTC.