How to stop Capital/Revenue tax avoidance and save the real economy.
The real economy is of course the supply of goods and services to satisfy peoples needs and some wants. In income tax, gains of capital are not taxable and gains of revenue are taxable. The distinction is very real e.g. capital is the farm, and the sale of the farm is not taxable, and revenue is the sale of the produce from the farm which is taxable. And … anyway.
Because we have things like the Pandora and Panama papers we can see that huge amounts of tax revenue are being lost from governments around the world by the wealthy trying to turn revenue into capital as one of the ways to avoid tax. Every dollar of revenue turned to capital saves 28% (NZ tax rate for a company). This huge return on invested is gained by having a few clever accountants and lawyers to make sure you do it within the rules; or arguably so. We all know this.
This particular technique can be fixed relatively easily by simply removing for tax purposes the capital/revenue distinction for any non-individual entity. At this point every indoctrinated accountant is trying to find their hair, i.e. it is not without impacts; only one of them is paying tax. It is logical to remove this distinction because, unlike a natural person, everything a non-individual entity does is about protecting an economic asset or gaining money in some form (capital or revenue). So everything a non-individual gains is truly revenue. This exposes the absurdity of treating a legal tool, a company or trust etc, as a ‘person’ for tax. This honour of being called a ‘person’ has been savagely abused through tax avoidance. These entities are not simple extensions of people. Nothing remotely exists in a natural person like shareholding, — expanding and contracting the entity, extending and limiting share rights. Or having limited liability; as a person try telling that to your bank. Note; a ‘natural person’ would retain the capital/revenue distinction. And this is all in the context of a company flat tax of 10% with no deductions for expenses from traditional revenue. This generates more revenue but with a much lower rate of tax.
So with no distinction between capital/revenue for a non-individual, capital gain becomes revenue and taxable. That means any assets sold by a company would become taxable revenue. But tax avoidance is so much more than this. We are forced to consider many items of capital that come into the company, are also revenue, such as some loans. (Indoctrinated accountants may need a defibrillator at this point – Impossible! Can’t work! Destroy the economy!). We can make some exceptions. Loans from true arms length 3rd parties, i.e . based and registered in New Zealand to ensure our banking/finance market is stable and robust. Overseas banks hold a risk of tax avoidance.
To explain this a bit more. E.g, A New Zealand company has a rental in Australia. A management fee is paid and a loan is used to finance the rental; reducing taxable income in Australia and the fees and interest are taxable income to who receives it. But if paid back to an entity in a tax haven, no tax. The NZ rental owner rather than bringing taxable revenue back may send it back as a loan from the tax haven so it is not taxable here because loans are capital. And in New Zealand interest for having that sneaky loan is deductible from New Zealand tax. This structure has to be hidden. Then the New Zealand owner doesn’t mind paying a high interest rate, it’s tax deductible from our taxes. These loan can be written off which can create other tax opportunities.
There is also the problem that an asset purchased may be used by the company in making goods and services. If we put 10% on these assets that would increase costs and push up inflation. So an exemption would be needed so these purshase are not seen as income coming in, e.g., a non-individual importer of coffee gets beans from overseas. This asset coming into the company would not be subject to tax. So the production test would be that the asset is consumed in the supply of the goods or services.
If the company purchases a fixed asset property to run a business from the premises this would be taxed in full on disposal, but should it be taxed on coming into the company? The answer is; yes. Because we don’t want our economic wealth diverted into holding of assets as the path to wealth creation, which is what is currently incentivised. Investment is needed into the production of goods and services. So the impact of taxing up front is that either individuals will make the purchases, (a venture? They will pay individual tax rates on their revenue). Or the company will simply rent the premises. Or go into a venture on development of the site to rent it. Whatever way, taxation up front in addition to at the end, dissuades investment in capital assets and solidifies that the path to wealth is the supply of good and services to people and not the holding of assets which is currently destroying our economy. It does not stop the holding of assets but you will pay tax if you chose to. The double tax effect encourages the idea that capital investments are longer term investments not flick on and off for quick profits.
Some other fixed assets that aid the delivery of the goods and services by business could be exempt, if they were tangible assets. e.g. Tables, chairs in a restaurant. But all disposals will be subject to tax. I’ve already said previously that to encourage employment in New Zealand; salary and wages are deductible from revenue where we can track PAYE payments through Inland Revenue. A call centre overseas would not get a deduction for salary and wages.
Then there are all the other assets, the shares in other companies, options , etc. These will be very hard to hide because companies need these in the financial accounts to attract investment and show how wealthy they are to stabilise loans. Consequentially it will be very hard for companies to avoid tax for assets coming in or going out. The response will be firms will get bigger to minimise tax, so there are not inter company share swaps or transfers gettng caught by tax. This is good because they will become more transparent and consequentially avoidance will be harder to undertake. I have also written previously about share market impacts.
Another outcome is losses are not allowed. A salary and wage earner pays high tax one year in a good job; changes job and goes to a low salary. Did they over pay the previous year? No, its irrelevant. They can’t spread tax over more than a year. The same should apply to non-individuals. We should only tax income and gains and loses are carried by the individual or non-individual. Business is their risk. Losses are not socialised onto taxpayers as that sets a bad market signal around taking risks. Without the allowance of expenses loses can’t occur. On removing capital/revenue distinction we will only tax gains, no losses allowed. Losses demonstrate the priviledged status we give business over ordinary people. Losses have encouraged tax avoidance practises which undermine our economy.
Losses are probably the main reason why Jacinda said no to capital gains taxes. It was all lies from Treasury and Inland Revenue. The idea of a sharemarket fall generating huge capital losses which would wipe out all the revenue for government for a few years meaning massive borrowing to run the government. All lies because of the lack of imagination within the mandarins to imagine an economy different from the one they have been blindly indoctrinated into. New Zealand for sometime has been poorly served. Asset based economies like we currently have are unstable and have repeatedly needed massive bailouts, e.g., 2008 and 2020; and Liz Truss in the UK. We have to change to survive and our mandarins aren’t doing it.
The current laws and policies are feeding an economy fixated on a path to wealth around the holding of capital assets. Taxation and ownership laws are driving it. In response fringe insubstantial economic businesses have arisen based on immigration driving demand in the economy. And education is a profit driven business with a focus on educating overseas people. Are New Zealand’s economic interests actually being served?
Change is relatively simple. It will be traumatic for larger businesses, but this trauma will open up huge opportunities for smaller low cost businesses to arise as they will be more competitive. It does not take away the massive wealth that has already accumulated within large business, so they will have huge scope and financial resources to adapt. But here are the steps to getting our economy back onto the path of wealth creation through the supply of goods and services to ordinary people.
And these changes will completely change the current business incentive to angst about chocking off wages to hold inflation and moaning about government largess driving inflation while they gleefully raise their prices. Now they will have a huge incentive to ensure ordinary people are paid well enough to buy the goods and services that business need to sell in order to make money. Just like Henry Ford paid his workers well so they could buy his cars and keep his factories going. The whole dynamic that currently drives inflation will change. These changes will help bring back an element of a Keynesian demand driven economy that works for the benefit of all classes like an economy is supposed to do; to meet the needs and some of the wants of all people.
Know a very reputable builder he gets tax audited by IRD every 5 years. I wonder how often some of the new builders get audited, as it seems that new companies should be allowed to rip people off, destroy the environment and remove safety from NZ construction. Fine $4500. Note CTV building with a fake engineer killed 115 people, more than double Tarrant and the Mall killer combined.
Shoddily-built house ordered demolished after builder forged inspection reports
https://www.nzherald.co.nz/nz/shoddily-built-house-ordered-demolished-after-builder-forged-inspection-reports/HT4NSQK3EVDW5JKMIWLGNMO2XU/
Held criminally liable, HELL NO! This is NZ we love ILLEGAL and NON CODE buildings! Just a little fine and a wink, wink when caught.
Illegal worker death. Wokesafe will not prosecute, police, IRD, Immigration will not prosecute. Tick for more of the same and ACC pays out to overseas without a premium being made!
https://www.nzherald.co.nz/nz/illegally-working-overstayer-dies-on-the-job-acc-payment-made-to-widow-in-china/OWADEJMGCUYM36WLF6YNKUA2SE/
IRD missing in action on the amount of cash in construction with hundreds/thousands companies and teams of illegal labour now operating outside of taxation and other standards like labour and building code in NZ.
Thoughtful Stephen. Probably a good many who don’t agree – or at best find reason to nit-pick some of the points – but it could be argued the former in particular simply have skin in the game.
… All lies because of the lack of imagination within the mandarins to imagine an economy different from the one they have been blindly indoctrinated into…
The way you frame it, is there really any hope for transformative change? Who is going to effect that? Agency in this case is far from straightforward?
This is so incredibly silly. Particularly the bit about losses. So basically you would like NZ to destroy our entire start up industry? No more R&D and new tech companies in NZ? Seriously, do you want us all reduced to poverty?
[Because we have things like the Pandora and Panama papers we can see that huge amounts of tax revenue are being lost from governments around the world by the wealthy trying to turn revenue into capital as one of the ways to avoid tax.]
Converting income into capital is a normal process if income is saved instead of being spent on consumption. Money saved is available for investment and therefor may be used as capital. The problem you are attempting to address is one of law enforcement rather than one relating to “the conversion of income into capital”. NZ citizens are liable for tax on all their income worldwide, and therefor should pay tax on any income they receive before it is converted into capital.
[It is logical to remove this distinction because, unlike a natural person, everything a non-individual entity does is about protecting an economic asset or gaining money in some form (capital or revenue)]
The purpose of corporatism is to protect shareholders from liability for the corporation’s liabilities: there is no way that I would invest in company if I thought that I might lose my house in the event of the company going belly up. The invention of the”joint-stock company” is beneficial because it allows companies to attract small investments from lots of people.
Companies do not own capital, they own assets. Capital is owned by the proprietors or shareholders of firms or companies. This is why the “capital account is always a credit balance in a balance sheet – a credit balance denotes the fact that it owned outside the firm.
[If the company purchases a fixed asset property to run a business from the premises this would be taxed in full on disposal, but should it be taxed on coming into the company? The answer is; yes. Because we don’t want our economic wealth diverted into holding of assets as the path to wealth creation,]
Why? Surely we should like to see wealth created. The issue, if there is one, surely relates to the question of who owns the wealth rather than the creation of wealth itself.
Hi Mikesh thank you for your comments.
Your first point is you support the growth economy arguments. I’m saying that the growth is too much in capital asset inflation. Growth needs to be in the provision of goods and services. My previous article on The fundamental flaw in our economy quotes the book ‘Takers and Makers’ that in the US only 15% of capital is going back to business making things. The rest is churning into assets like stock. The growth economy is failing because it is diverting investment away from real growth. And its is not being distributed. You can’t ignore some of getting very wealthy and most are going backwards
Your second point, I’m not suggesting fully removing limited liability. But there needs to be a boundary on it. It’s being abused. Your point on capital is taken. I was aiming for 1000 words and went over. For continuity and to keep it short I used the word capital because it is know as the capital revenue distinction. I’m not writing a text book. On this point, you might be not being seeing the wood for the trees?
Your third point. Yes I want to see wealth created but the path of capital asset inflation we currently have is failing the purpose of he economy. People aren’t getting what they need. Your point who owns the wealth can’t be dealt with currently because it is so easy to play and avoid the tax rules. I’m showing how to tighten them.
There is nothing in my comments that can be regarded as growth oriented. Investment will always be needed if only to replace existing assets after they are no longer serviceable. I agree that there is insufficient distribution of wealth as it is created, but trying to blur the distinction between capital and income will not emedy that problem. The problem seems to be that too much money is being created through the banking system and going into non productive areas like the trading of shares and property.
I am inclined to think that company tax should be at zero percent with the proviso that all profits be paid in the form of dividends to shareholders, who would then pay the tax on those dividends at their respective tax rates.
I enjoyed the article Stephen
Transaction tax is so vehemently opposed by the rich…it convinces me it must benefit the many…at the expense of…the few.
I would think the poor would also affected negatively by a transactions tax, so I would think that their would be some opposition from them as well.
“There is also the problem that an asset purchased may be used by the company in making goods and services.” We use depreciation at the moment & it is not broken so no need to fix it.
While I like the intent of the article to reduce/eliminate tax avoidance there must be a better way to achieve that purpose.