The IRD recently released an officials paper on Resident Land Withholding Tax, a tax to apply to offshore sellers of residential land, who have held the land for less than two years, (except for the main family home).
The withholding tax is an estimate of the income tax liability a seller may have. It does not remove the requirement for a tax return to be lodged.
However, according to Leicester Gouwland of William Buck Christmas Gouwland, an Auckland based accounting firm, analysis of the officials paper reveals four problems. The proposed withholding is excessive; it places onerous responsibilities on the lawyer or the conveyancing agent; it will apply to residents as well as offshore sellers; it may leave creditors out of pocket.
The proposed withholding tax is the lower of 33% of the gain, or 10% of the sale price.
The tax rate of 33% appears to be chosen because this is the rate of resident withholding tax on dividends. Where is the logic for this? It is not residents that are being subject to this tax.
The tax rate of 10% of the gain, on the other hand, is advanced on the basis of rates used by other countries.
The Officials suggest that this approach of the lower of two calculations is both because it is simple, and because it approximates the tax payable.
However a simple analysis shows that the proposed withholding tax rates will be well in excess of the likely tax, particularly as there is no allowance for any costs such as real estate agents fees and past losses. Regardless, in comparison with the company tax rate of 28%, companies will be overtaxed at least 5 percentage points.
Therefore the 10% rate based on the sale of the property could logically be reduced to under 5%.
Take, for example, a property sold for $500,000 with a profit of $50,000 and before sale costs of $20,000. According to the paper, the options are either 10% of the sale price ($50,000 tax), or 33% of profit ($16,667 tax). Therefore the tax owed is $16,667, being the lower of the two figures.
However, the real profit figure is of course $30,000, once the before sale costs are removed from the sale price. Taxing the actual $30,000 profit at the company tax rate of 28% would mean $8,400 tax. Taxing it at the individual tax rates (10.5% below $14K and 17.5% above $14K) would mean $4,270 tax.
To repeat, tax under this new regime is $16,667. Using either of the tax rates in place would mean either $8,400 or $4,270 tax. What is the justification for doubling or quadrupling current tax rates?
Let’s look at a second example. In this case the sale price is $1,000,000, the profit is $150,000 and the before sale costs are $30,000. So the options are either 10% of the sale price ($100,000 tax), or 33% of profit ($49,500 tax). Therefore the tax owed is $49,500, being the lower of the two figures.
Taxing the actual 120,000 profit at the company tax rate of 28% would mean $33,600 tax. Taxing it at the individual tax rates would mean $30,520 tax. Again, what is the justification for the huge difference?
One point that is not clear is the interest rate that will be paid for overpayment. Will it be enough to compensate for the lost opportunity the taxpayer had for the money?
The solution is to have different rates of withholding tax for different levels of gains. The withholding tax rates on the profit could start at 10% and rise to 25%. For companies the tax rates could start at 15% and rise to 25%.
A further allowance should be to enable any losses to be deducted from any gain. To tax someone who clearly has no tax obligation is unacceptable.
These changes are not complicated, and would not require the payer to obtain any further information apart from the losses available. This information is readily available.
The officials propose that the conveyancing agent, usually a lawyer, will be responsible for the deduction and payment of the tax. The officials prefer the purchaser’s solicitor to be the agent, even though it is the seller who is subject to the tax. Therefore the legislation is shifting the burden of the compliance cost to an innocent third party.
The obligation of the agent will also include determining whether the withholding tax needs to be deducted in the first place. This places the agent in the position of being subject to IRD penalties should they get it wrong. How is it possibly fair to penalise the agent for acting as the IRD’s tax agent, particularly when the fee is typically relatively modest?
While the intent of the withholding tax is to tax offshore persons, the actual plan is to tax residents as well. This seems odd because New Zealand tax residents are already in the New Zealand tax system, lodging annual income tax returns.
For instance, a New Zealand company that is 25% or more owned by an offshore company or individual will treated as being offshore. Clearly, if for example, 25% is owned offshore, then 75% must be locally owned.
The officials suggest that these rules are required to prevent offshore individuals circumventing the rules by using companies. However, it is hard to understand where there is tax avoidance if the company is already paying tax in the New Zealand system. Surely this is therefore nothing more than an additional, unnecessary, compliance burden.
Of significant concern to creditors, particularly banks, is the officials’ belief that withholding tax should be paid before other creditors are paid. This is an unnecessarily aggressive position, particularly where tax is deducted in situations where no tax is payable!
Currently, where the subject property is also securing other loans, it is common for the bank to require all of the sale proceeds to be paid to the bank. In fact this is sometimes the reason for the sale in the first place. By taking priority over the private sector, the IRD is putting the security banks hold at risk. Without doubt the effect will be to shift the tax burden to others.
The legislation comes into effect on 1 July 2016. Time is running out for the officials to refine their views, to ensure a more sensible and workable system is enacted.
For further information contact your local advisor.