KEY POINTS:
New Zealand's tax system, once a simple and effective method of gathering Government revenue, will be riven with even more distortions now the company tax rate has been dropped to 30 cents, says a leading tax accountant.
Finance Minister Michael Cullen announced a reduction in the headline rate
of corporate tax from 33 per cent to 30 per cent in this week's Budget.
Coming into force next April, the cost of the reduction is expected to be $675 million in the first full year.
It now means company tax rates are well below the top personal tax rate of 39 cents in the dollar.
Craig Macalister, tax director at the Institute of Chartered Accountants, estimates 115,000 partnerships and sole traders will be missing out on these latest company tax cuts. This kind of structure is particularly popular for rural-based businesses and farmers.
"Business tax rates should not be changed in isolation, especially in the New Zealand context. We've got a large number of sole traders and partnerships operating in New Zealand, and lowering the company tax rate does nothing for them," says Macalister.
Rural businesses and farms historically favoured these structures, which work well with family arrangements. Many preferred the flexibility given for distributing income around the family, which was harder to achieve through a company.
It is not expensive or difficult to set up a company in New Zealand - it doesn't even usually require a visit to a lawyer or accountant.
But there is a real cost, particularly for New Zealand's farmers, when it comes to moving assets from one entity to the new company.
Assets needed to be "realized" when moved over to the new company - which could mean tax being levied on profits when they were transferred.
This might not make much difference to a sole trader painter or builder, but for a farmer this could mean paying tax on hundreds of thousands of dollars of "profit" being realized on the livestock.
The institute had lobbied the Government to allow the transfer of assets such as livestock at "book value", so a business could move from a partnership to company structure without having to pay this tax.
"What they could have done and should have done is allow people to incorporate - to get that 30 cent tax rate if they want to, without tax cost impediments thrown in their way.
"People are going to now look at 'perhaps I won't shift my assets into this company structure, but what I might do is put a company in my wider family structure and somehow divert earnings through that'."
This was becoming increasingly popular among professionals trying to avoid paying the top tax rate of 39 cents in the dollar.
"The difference between 39 cents and 30 is now more incentive to enter into a structure to divert your earnings through a company.
"You are going to end up with more IRD focus and attention on that, which is all deadweight costs. It's not helping the economy to move forward in any way," says Macalister.
"Pre-2000 we had a cracker of a tax system, but ever since that increase of the tax rate to 39 cents in the dollar, the great tax system we once had is slowly being eroded to a tax system that is now full of distortions all over the place - taxing different sorts of things at different tax rates."
Don Nicolson, vice-president of Federated Farmers, says the group had, for many years, been promoting lower rates for both business and personal tax.
"When you alter the tax thresholds, of course you get businesses scurrying to minimise taxation effects and so we've seen a growth in trusts and the like," he says.
The past six to eight years have seen many turning to trusts - not just to minimise tax but for reasons to do with matrimonial property and succession planning.
If farmers did move into a company structure from being sole traders, they would still have to pay themselves a wage, and if they wanted a reasonable standard of living. They would have to keep paying the higher personal tax rates.
"What does all this do, what do Dr Cullen's initiatives ever achieve?" asks Nicolson. "The need for more creativity by tax consultants, accountants and lawyers who set up these structures. They will find another structure that will benefit their clients.
"I am a bit cynical about this. The winners out of all of this are generally the people who do this creativity, they get a job out of it. These new rules will give accountants and planners and tax advisers another job.
"We don't see any merit in that - personal tax rates should have been cut at the same time."
At a glance
* Company tax rates are being dropped from 33 cents in the dollar to 30 cents.
* This will not apply to the 115,000 partnerships, sole traders or trusts.
* This kind of structure is particularly popular for farmers and rural businesses.
* With the top personal tax rate - 39 cents in the dollar - now so much higher than the company rate, opponents say more and more money will be spent on attempts to devise tax efficient business structures.
* Farmers can get hit with a big tax bill if they move to a company structure.
