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What is the problem?
Many millionaires are paying taxes at a lower rate than the lowest income in the country.
We found this out in a Treasury report (which you can read below), which attempted to measure how wealth is distributed. The key takeaway: 42 percent of the richest kiwis pay less than 10 percent of their total income in taxes.
The lowest income tax rate is 10.5 percent, paid by wage earners on income of up to $ 14,000.
Some people, including the Green Party, think it is a big problem and have reiterated that a tax reform is necessary.
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it’s fine. So how does it work?
Most people pay taxes on earnings from their work.
Typical different income bands, such as wages, salaries, and benefits, range from 10.5 percent for earnings up to $ 14,000 to 33 percent for earnings over $ 70,000.
Effective April 1, a new high-level tax rate of 39 percent applies to earnings over $ 180,000.
The very rich don’t have normal jobs, so they don’t pay taxes like most of us.
Many get most of their income from elsewhere, with wealth tied, for example, to companies they own or investment assets.
Different tax rates apply to different types of businesses. But most companies are subject to a 28 percent tax rate, and trusts (and trustees) are subject to a 33 percent tax on profits.
You can already see that a problem is brewing … a 28 percent rate is much lower than the 39 and 33 percent fees charged (or will be charged) to Kiwis working high-income jobs.
Tax consultant Terry Baucher describes a simple example of a person who is paid a salary of $ 200,000. They will pay income taxes for that.
But if they (or your business) also have assets, and those assets increase in value by $ 800,000 over a year, that person’s income is $ 1 million. The $ 800,000 increase may not be taxable.
The wealthiest New Zealanders pay most of our taxes, says Geof Nightingale, a partner at PwC and a member of the government’s Tax Task Force 2018-19.
“But that tax as a percentage of your income is at a lower rate than many of us who work normal salaried jobs.”
It is important to remember that the rich are not doing anything illegal. As Nightingale says, they are simply obeying the fiscal policy configurations that successive governments have chosen.
The question is: are we comfortable with that as a society? And is that fair?
Imagine you own a company that makes millions every year
Let’s take a very simple example of a company that posts a profit of $ 2 million. The company is owned by a single person who pays himself a salary of $ 200,000 from the profits.
That salary is subject to regular income tax, everything over $ 70,000 is taxed at 33 percent (and since April, everything over $ 180,000 is taxed at a rate of 39 percent).
The company has $ 1.8 million left in profits. If the owner wanted to take this out and pay himself as a dividend, he would be taxed, so he decides to leave it with the company.
Sure, you’re subject to the 28 percent business tax rate, roughly the same rate as Kiwis working a job that pays between $ 48,000 and $ 70,000. But it is not subject to 33 percent or 39 percent.
Now, let’s say the wealthy owner decides, after running this business for 10 years, that it’s time to sell. They have the company valued, and it turns out to be worth $ 10 million.
The rich have all the cards in the tax game.
The owner, who invested $ 2 million in the company over the years, walks away with a profit of $ 8 million. This is a capital gain and is not taxable.
The former owner of the company, seeing a trendy real estate market, decides to buy four rental properties in Auckland.
They rent those properties for six years and finally say enough is enough, it’s time to cash in and retire. Those properties are now worth $ 16 million. Since this person has waited five years, the sale is not subject to the bright line test and is not subject to tax.
(Some real estate investors can be caught by the bright line test, which taxes capital gains as income. The rule can affect anyone who buys and sells investment property after October 1, 2015).
“Suddenly, a business that makes $ 2 million has become $ 16 million and the owner doesn’t pay taxes,” says Nightingale.
“All of that is totally legitimate in the current tax setup, but is that the correct result?”
But there is more
If a person owns two (or more) businesses and one makes a profit and the other has a loss, that person can use (or offset) that loss to lower their tax bill.
So if you own a business that makes $ 10 million a year and another company loses $ 1 million, you can only pay taxes on $ 9 million, explains Connie Lui, director of NZ International Tax & Property Advisors.
And if, for example, the loss-making business was a vacation spot, it may be turning into a loss, but its assets could be appreciating. After a while, the owner may want to sell.
“The capital gains from the sale of the resort may well make up for all the losses the company had in the past,” Liu says.
Again, that capital gain is not taxable.
Tell me more about capital gains.
New Zealand has been talking about taxing capital gains forever, but despite significant pressure, Prime Minister Jacinda Ardern scrapped it.
Simply put, if you buy some assets (such as stocks or property), you may not be required to pay taxes if you make a profit when you later sell.
The rules also say that if you are buying and selling assets regularly, that is essentially how you earn income, and you have to pay taxes accordingly.
Section CB 4 of the Income Tax Act of 2007 says: “The amount that a person obtains from the alienation of personal property is the income of the person if he acquired the property for the purpose to get rid of it”.
Keywords are highlighted. If you bought an asset with the intention of selling it later, you are looking to make money and must pay taxes.
Here Liu offers the example of a million dollar painting. If a person buys a painting for $ 1 million and plans to sell it in a year for $ 2 million, that profit would be taxable.
But this is a really gray area. Surely you could buy the painting and not sign, or tell anyone, were you planning to sell it? And a year from now, decide that you tell everyone you were sick of looking at it and withdraw the money.
The question is then: Will you pay any taxes?
Just raise corporate tax if that’s where the rich man’s money is?
It’s not that simple, says Nightingale. The argument is that a 28 percent tax rate encourages people to invest money in businesses and in doing so creates jobs.
The Greens have proposed a wealth tax or a charge on the assets of the rich to avoid this. (There is a good explanation here).
The problem with this approach is that you are looking to tax an asset that does not necessarily generate enough cash to pay taxes.
Consider the example above where an individual’s money is tied up in four houses in the Auckland housing market. Sure, those houses are generating rent, but they won’t generate the cash needed to pay taxes.
“If there were a wealth tax of, say, 5 percent, you’d have to find $ 1 million of cash flow a year to pay off $ 20 million worth of assets. And you may not have it. You have the wealth, but not the cash flow, ”says Nightingale.
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You could sell this jet and pay no taxes on it.
What about trusts?
There are around 250,000 family trusts in New Zealand. They work by allowing one person to transfer assets to a trust to benefit other individuals (legally called beneficiaries).
Income earned by a trust may be retained by the trust or it may be distributed to the beneficiaries of the trust.
That income is taxed at a rate of 33 percent, the same as the personal income tax rate. But remember that on April 1, the highest income tax goes up to 39 percent.
So let’s go back to the $ 2 million business example. Let’s say the shares of the company are held in a trust.
The trustees (the ones who run the trust) could decide to take the $ 1.8 million profit paid by the company and pay it off. It would be taxable at a rate of 33 percent, not 39 percent.
“So even after the tax rate goes up to 39 percent, the homeowner could legitimately keep his income taxed at 33 percent,” says Nightingale.
The government says it will act if trusts are being used to evade taxes, but it does not want to.
The problem, Nightingale says, is that the very wealthy don’t even need to use trusts like this.
“Unlike most of us, they generally don’t consume all of their income every year. And then the income they do not consume can be accumulated within companies ”.
So what do we do?
“All of this brings me back into the forbidden territory of capital gains, on a performance basis (when you sell your asset),” says Nightingale.
In the case of the person who bought four properties in Auckland, someone bought assets, someone sold assets, cash was exchanged to pay, and the person who makes a profit must pay taxes on it.
Baucher agrees: “The answer is some form of capital gains tax.”
All the examples cited above are very simple and do not exactly reflect real life.
When Baucher speaks, he describes the reality of the tax system. A confusing maze of opportunity and confusion, where people pay taxes on bonds and currency accounts, time deposits, gold, and cryptocurrencies, but not necessarily on the earnings from the properties they buy.
He points out that New Zealand is unique in the world. We do not tax inheritance, capital gains, or wealth.
On the introduction of capital gains, he says: “A hoax has been promoted: capital gains are complicated. Is not.
Most Western countries tax one, two, or three of those things. We do not
“The capital gains tax is very simple. You bought something. You sold something. We will tax the difference. How much we tax and how complexity comes into play. But the idea of taxing the profit is simple. “
Everything returns to the property, says Baucher. It’s the extremely easy option that skews investments as a whole in New Zealand.
“To make money in New Zealand, it is quite simple. Borrow from the bank. Buy a piece of land and sit on it. Work done. That’s not productive, but it makes perfect fiscal sense. “
