KEY POINTS:
Cuts in corporate dividend payouts and a surge in business rorting the taxpayer through a trough full of tax credits are being touted as consequences of the Government's latest business tax cut plans.
Finance Minister Michael Cullen has put a figure on how much business can expect to gain from imminent corporate tax cuts - $1 billion.
Of this, $540 million will stem from lowering company tax rates from 33c in the dollar to 30c.
The rest will flow through a range of tax credit schemes, designed to encourage favoured Government results - research and development, export market development and skills training. PricewaterhouseCoopers New Zealand chairman John Shewan says this is a lot of money for tax breaks; money spent in a manner that "is not an appropriate way to confer tax cuts".
While the decision to cut corporate tax rates has met with predictable acclaim from the business community, Business NZ chief executive Phil O'Reilly warns about the rorts that can flow from poorly executed tax credit schemes.
Shewan thinks the drop in company tax rates should advantage those companies choosing to leave profits in the business, rather than paying out in dividends to shareholders. This is because many of the shareholders will be paying higher tax rates on the dividend payout, since their own personal tax rate is likely to be higher than 30c in the dollar - up to 39c.
New Zealand listed companies traditionally have a higher rate of dividend payout than their overseas counterparts, so any move to cut company tax rates may change this.
The needs of smaller, retail investors are often different from those of the big institutions, with "mum and dad" investors often valuing good dividend income as much as share price increases.
O'Reilly and Shewan invoke the spectre of massive distortions and rorts they believe will flow from the Government offering generous tax credits to those companies willing to spend money in approved areas.
Shewan says similar schemes in the early 80s "nearly brought our tax system to its knees" with business decisions being made solely around the availability of tax credits.
Export promotion activity curiously took place around the same time as Olympic Games, World Cups and Commonwealth Games.
Shewan says the lessons of the 80s have not been learned - with widespread tax breaks but high personal tax rates, companies changed behaviour to enjoy windfalls from poorly thought-through tax incentives.
New Zealand has a very effective tax system - the "unsung hero" of the economy, says Shewan, now bringing $1 billion a week into Government coffers.
O'Reilly says that while the Government wants to use the tax system to "send a signal to business", - the conversation will be more like being hit over the head.
Tax credits for favoured businesses and sectors are easily politicised and open to being rorted.
He does not approve of any of the tax credit schemes outlined by the Government, but hates some less than others. First and least distasteful is tax credits for research and development. Similar schemes are common overseas, he says, with 19 OECD countries already offering them. Another point O'Reilly says works in their favour is that private sector R&D spending in New Zealand is low by world standards.
The Government is proposing a tax credit of 7-15 per cent for R&D spending. Government officials earlier this year said eligibility for R&D credits should be as inclusive as possible, easily understood and when applied, not impose unnecessary compliance costs.
Such criteria, say Shewan and O'Reilly, open the door wide to companies seeking to exploit the taxpayer.
Offering tax credits for skills training is a particular invitation to abuse, says O'Reilly.
Officials have suggested such a credit would be used to reward "training linked to qualifications on a National Qualifications Framework".
Money spent on things such as course fees, instructors, rental fees of training facilities and the purchase of textbooks would all earn a tax credit for the company. It would not cover wages or salaries paid to employees while training, nor travel and accommodation.
"I can't see it working the way the Government intends," says O'Reilly. What counted as skills training for one person might not be acceptable to another, he says. Skills were often built informally and there was massive potential for rorting the system. "Courses? Golf courses..." he says.
Only one other OECD country, Spain, had introduced such a tax credit and it had recently moved to abandon it.
Using tax credits to achieve goals such as export market development and skills is part of the Government's economic transformation plans.
Earlier this year, Cullen described the business tax review as an important part of the Government's strategy to "facilitate the progressive transformation of our economy into a higher-wage, higher-skill and more knowledge-based economy".
Exporting as a proportion of GDP had "barely changed" in recent decades and if New Zealand was to climb the OECD ladder, it had to encourage higher-value exporting.
On the export market development front, Government officials are suggesting helping businesses which spend money on bringing overseas buyers to New Zealand, to attend trade shows and events. Overseas advertising and promotion would also attract a tax break. However, business done in Australia would not count for this, as it is classified as a home market under CER rules.
Some of those big foreign exchange earners - tourism and education for foreign students - would not be eligible for any of these tax credits.
John Shewan says the three areas chosen for tax breaks - export market development, skills training and R&D - could very well be the "thin end of the wedge" with pressure building on future Governments to start including other sectors of the economy.
Companies helping achieve Government's environmental goals or climate change targets could well be next in line, asking for some tax relief of their own.
Taking advantage of business tax cuts
By Bridget Carter
Lawyers, doctors and farmers are expected to start switching business models in the next year so they can benefit from future tax cuts.
Economic commentators say sectors such as farming will see little advantage from Government plans to lower incorporated company tax by 3c in the dollar, taking the tax rate down from 33 per cent to 30 per cent.
This is because most farmers do not run their businesses as companies.
Federated Farmers manager of general policy Nick Clark anticipates some farmers will now move to the company model.
He says a farm is run as a partnership, say by a husband and wife, or by a sole proprietor.
This means they do no need to pay company compliance costs.
"They usually set up as a partnership or a sole trader. Law firms and doctors are the same. What this means is that the Government is giving preferential treatment for certain organisations."
Finance Minister Michael Cullen announced that $1 billion worth of tax cuts will be offered to companies from April 2008, and he says the intent is to prevent big business being lured off-shore.
Clark adds that while trying to match Australia's 30 per cent tax rate for business is fine, the tax cuts should be broad based.
People should talk to their accountant or the Companies Office about the costs of changing their business structure, he says.
Tax director at the Institute of Chartered Accountants Craig MacAlister says changing from a partnership arrangement to a company structure can be costly because you have to pay tax on your assets.
"You are effectively buying your assets back and you are taxed on the transfer. It is like unrealised trading costs. When you move from one structure to another, you have to pay tax on everything."
Federated Farmers vice-president Don Nicholson says that for most small businesses it is the personal income tax rate that is important.
"We consider it critical that the Government moves to reduce both rates," he says.
"Farmers are struggling with escalating costs, and high interest and exchange rates. Most would use the proceeds of a tax cut to invest in their businesses."
Nicholson says that while he agrees with Cullen's concerns about inflationary pressures, he cannot understand why Cullen is increasing Government spending by 8 per cent in 2005-2006 and that he considers this less inflationary than modest tax cuts.
- HERALD ON SUNDAY
