In last year's budget there were a number of measures designed to simplify the tax processes. These have now been enacted and in this post we cover those changes that come into effect from 1 April 2017. As with previous tax simplification processes, sometimes the result imposes extra burdens on business owners. So, not simpler at all.
While some of the changes will start from 1 April 2018, here's a short outline of the changes that come into effect in April 2017.
1. Provisional Tax- Safe Harbour Threshold
At the moment, individuals who have residual income tax of more than $50,000 (ie approximately $180,000 of income that is not taxed at source) are subject to IRD's use of money interest. The interest rate is currently 8.27% so it is well above bank lending rates. The threshold has been increased to $60,000, which is roughly equal to untaxed income of $210,000. And there is more- this safe harbour threshold has been extended to also include companies, trusts and other entities. For a company, that equates to a taxable profit of $214,000 and for a trust the taxable profit level is $181,000.
There is a catch though. If your business interests involve more than company or more than one 50% shareholder (and therefore specific associated party rules comes into play) then it will be a case of all or none. That is, all the associates must be eligible in order for any entity to be eligible.
We have hated the punitive nature of the use of money interest charges and have generally looked at provisional tax payments for all clients to make sure that they are paying the right amount throughout the year so they do not end up paying too much interest as well. But because income is not always earned equally throughout the year, it has been inevitable that some interest is incurred. In those circumstances we have turned to tax pooling agents, Tax Management New Zealand (TMNZ), so that we can access a lower interest rate. We will no longer have to pay so much attention to the provisional tax calculations so long as provisional tax payments are based on an uplift of 5% on the last years’ tax commitment.
2. Use of Money Interest
At the moment, if the amount of provisional tax paid in each of the first two instalments is not at least 1/3rd
of the final tax liability for the year then IRD charges use of money interest at their usurious rate of 8.27%. We have always disliked this charge because there is no way anyone can know for certain in August (when the first payment is due) what they will be earning by the end of March the following year. This is especially true where a business is seasonal or where a business is growing rapidly.
For companies, trusts and individuals who have tax of more than the new safe harbour threshold of $60,000, if they use the standard uplift method of calculating their first two provisional tax payments then interest will only apply from the last instalment of provisional tax due on 7 May. By that date the level of income can be determined with a fair amount of accuracy. What this means is that if you are under the $60,000 safe harbour threshold (and do take note of the catch re associates) then the final payment can be estimated and interest will only apply from the date of the final payment.
This means that we will shift our attention more closely to the final provisional tax calculation and will need to consider whether there is merit in estimating down for the final instalment. We are in the lucky position where most of our clients use Xero so it is possible for us to see where profits stand for the year. We are reliant on you making sure the financial records are both up to date and accurate, so if you think you could do with some help to improve your record keeping, just give us a call (just not on the payment date, please…………).
If you are not eligible for the $60,000 safe harbour threshold and expect that your income is likely to be less than the previous year then it is always possible to estimate your tax down during the year. We always advise caution around tax estimates because as soon as this is done, then the interest rules come into play from the first instalment. Interest will still be payable if you decide to estimate tax down, so please do talk to us before you talk to IRD.
3. Removal of Monthly late payment penalties
At the moment, if tax is paid late IRD charges late payment penalties of 1% for being a day late and a further 4% for being a week late. They then continue and charge an additional 1% every month thereafter, so it is not surprising that tax arrears can grow very, very quickly. That's the reason why, if you know that you can't pay your taxes on the due date, you should still file the return with IRD and also talk to them about a payment arrangement. IRD does not charge late payment penalties when you are in a payment arrangement so long as you pay the arrears as agreed and also keep up to date with subsequent tax payments while the arrangement is in place.
This results in annual interest savings for tax arrears of 12% pa, although it is worthwhile noting that the real kicker is the 5% late payment penalty if you are a week overdue. That's really expensive funding!
4. Private use of Motor Vehicles
At the moment if a company provides a vehicle to a shareholder employee then that vehicle will be subject to FBT. There are some good things about this - the company can claim all the GST on the purchase of the vehicle as well as all the running costs of the vehicle. In return, FBT will be payable.
There are completely different rules for sole traders or partnerships and these rules are much easier to apply. For these types of business structures, you need to keep a log book for three months every three years (over a representative period) to determine the percentage of business vs personal use. You can then use that percentage to work out how much of the vehicle running expenses can be claimed. If you don't maintain a log book, then the maximum that can be claimed is 25%, although the general practice seems to be that 25% can be claimed without any question. And when it comes to buying a vehicle you can claim back GST based on your expected business percentage.
From 1 April 2017, close companies (with 5 or fewer non-related shareholders) with no more than two vehicles that are caught within the FBT net will be able to apportion vehicle costs in the same way as individuals and partnerships can, resulting in a saving in time and FBT. The election to use the new rules will apply on a per shareholder and per vehicle basis and only from the date a vehicle is purchased. Further, a company can only use the new basis if the only fringe benefits made to all employees are a motor vehicle benefit to 1 or 2 shareholder-employees.
The exclusions to the use of this method for vehicle costs will mean that only very small companies with no more than two shareholders and very few employees will be eligible. As the number of employees grow it is very easy to fall within the FBT net and that will exclude many companies from being able to use this method.
5. Withholding Tax Rates for Contractors
At the moment the Schedular Payment Rules set out the rate of tax that needs to be deducted at source - for contractors this is generally at a rate of 20%. This is an effective means for IRD to collect the tax but because contractors may also incur significant costs to generate the income it can also mean that tax is overpaid during the year. This may be particularly relevant to real estate agents.
From 1 April 2017 contractors can decide their withholding tax rate, without requiring the consent of the payer. A minimum rate of 10% for resident contractors and 15% for non-resident contractors will be imposed. Where a contractor does not specify a rate, a default rate will apply. And IRD will also have the ability to require a higher withholding rate if the contractor is non-compliant with their tax obligations. The contractor will not be able to change their tax rate more than twice in any income year without the approval of the payer - this is to make it easier for the payer so they do not need to keep changing their records.
Labour-hire firms will also be subject to the withholding tax rules. Over the past few decades there has been an increase in the number of labour-hire companies who use contractors operating under company structures and it will no longer be possible for these contractors to avoid having tax deducted at source. The types of businesses that spring to mind in this area are recruitment companies who provide temporary or project-related staff or IT companies and construction services companies. The labour-hire firm will have to deduct withholding tax from payments they make to their contractors who work through a company structure..
It will also be possible for contractors who are not specifically covered under the current Schedular Payment Rules to opt in through voluntary withholding agreements where the contractors & principals agree to withhold tax. The obvious services that this voluntary opt-in will apply to is where contractors operate through a company structure but work directly with their clients. This will enable then to have some tax being paid directly to IRD by their clients. It could also potentially apply in the home services area - cleaners, gardeners, childcare services – but we suspect that most principals (ie households) would not agree to take on the role of tax collector.
IRD sees these changes as a good balance between making sure tax is being paid and giving contractors more control over their own tax affairs. We have a slightly different view. Recruitment and other labour-hire firms have systems in place to capture time worked for the ultimate client so that they can efficiently invoice their clients and pay their contractors. And that system is not the payroll system. So this change means a complete overhaul of systems to redirect data flows through a payroll system so they don't have to enter data twice.
IRD seems to have belatedly realised that as well. If a labour hire company needs to incur unreasonable costs to comply with the new legislation on 1 April 2017, then they can delay the start to no later than 1 July 2017.
This is not the full extent of tax simplification changes but it does cover the areas that we see most commonly. There are also changes to the way provisional tax is calculated that will come into effect from 1 April 2018. We'll cover these in detail in another post.
And this post is necessarily general and to be absolutely certain that you fit within the rules and exemptions you should always obtain specific advice on your situation.