The taxing business of taxing business
From the time the Tax Working Group released its long-awaited report on the design of the tax design, speculation has been rife on how the budget would fix a tax system which was widely regarded as “broken.”
Fundamentally for businesses, the enigma faced by government was how to balance the “big brother” comparisons with Australia, significant constraint through falling revenues and increasing expectations with the need to set businesses on the path to recovery.
Overall, the government has delivered a broadly neutral package for business.
In a surprise move to remain competitive with our neighbours New Zealand has finally got one up on the Australians by reducing the corporate tax rate to 28% from the 2012 tax year (generally April 1, 2011), a full year ahead of a similar move by the Australian government in its budget released earlier this month.
Unfortunately, if businesses are not currently making money the tax rate reduction won’t provide any immediate relief but does give a signal to the future of businesses as they move to profitability.
Likewise, to ensure the proliferation of foreign business ownership in New Zealand companies pay a greater share of tax in New Zealand, the thin capitalisation rules have been strengthened. Thin capitalisation refers to the extent to which a business is funded through debt rather than equity. Debt reduces New Zealand corporate tax liability (at 28% under the announced changes) replacing it with a withholding tax cost of 10%. The ratio of debt to assets has been reduced from 75% to 60%, meaning 18% more tax will be paid on 15% more profits earned by foreign owned businesses.
One of the key question marks is the effect other measures in the budget will have on businesses. Those measures include the increase in GST rate to 15% from 12.5% from October 1, 2010, the removal of depreciation from all buildings from the 2012 tax year, the removal of the 20% accelerated loading on deprecation on plant and equipment on all new acquisitions from budget day, and the reduction in personal tax rates.
While the increase in GST should be directly neutral on businesses, other than those involved in the supply of exempt services, the effect on consumer behaviour on these businesses is less certain. It is likely that an amount of knee-jerk consumer spending will result in the lead up to the change in GST rate which businesses will gear up for. The extent of the post-GST blues is less certain, particularly running into the traditional Christmas spending spree which may not eventuate this year.
The effect of the loss of depreciation claims on businesses is also uncertain. This will have a direct cash flow effect on businesses, whether as landlords or tenants, particularly as a significant number of small businesses also own their own premises. Many landlords have structured their affairs in the knowledge of the cash flow advantage that a deprecation claim provided. It is difficult to restructure their affairs given property is not a liquid asset at a time when other property owners are facing the same problem. Their only choice may be an increase in rents. Although there has been a timing advantage that historic depreciation provided, the removal of the deprecation claim will have an immediate negative cash flow impact on businesses.
The government has also signalled a review of the border between the building structure and what qualifies as fit out, which will inevitably lead to further denial of depreciation. To top off the bad news on this front, the government has removed the incentive to invest in business structure through the removal of the 20% loading of plant and equipment.
The final piece of the uncertain puzzle is the effect of the broad ranging personal tax cuts on business. Historically there has been an increase in consumer spending when personal tax cuts occur. However, the message given by the government is that such cuts are designed to offset the impact of GST and encourage individuals to save or reduce their personal debt levels. With interest rates projected to rise in the immediate future, it is likely the personal tax cuts will have a limited direct effect on buying behaviour and thus not result in a beneficial increase in consumer demand for businesses.
The government has stated the budget is about rebalancing the tax system for growth. That means less immediate benefits for businesses and more changes about how businesses are taxed; reducing the headline corporate tax rate, removing an incentive for investment in property and reducing the competitive advantage foreign-owned businesses have investing in New Zealand. All that is needed is a positive turn in the economic fortunes of the country to take advantage of these changes.
For further information, contact:
Greg Thompson
National Director, Tax
Partner, Tax
D +64 (0)4 495 3775
M +64 (0)21 281 7332
E greg.thompson@nz.gt.com