Inland Revenue today released the results of its High-Wealth Individuals (“HWI”) Research Project (“HWI Project”) where it calculates the median effective tax rate (“ETR”) of HWIs.
At the same time Treasury released its analysis regarding the median ETRs for the general population.
The headline grabbing outcome of the HWI Project report is that the median ETR paid by the high wealth families surveyed is a low 8.9% compared to the ETR borne by middle wealth New Zealanders of 20.2% based on Treasury analysis. Such outcomes are to be expected when, under current settings, intentionally non-taxable sources of earnings are included in the effective rate divisor.
Inland Revenue HWI Project results
Inland Revenue’s HWI Project calculates the ETRs of more than 300 of the wealthiest New Zealand tax residents and their direct household family members.
The initial threshold for inclusion in the HWI Project was estimated net worth in excess of $50 million, or net worth over $20 million if other factors were met. The final HWI Project group consisted of 311 individuals and their immediate families. The 2015 – 2021 income years were included in the study.
The main finding from Inland Revenue’s research is that the median ETR (tax paid divided by economic income) was 8.9% for the HWI Project group. This includes personal, company and trustee taxes. The median increases to 9.5% when GST is included.
Economic income is a broader concept than taxable income as it includes non-taxed forms of income, such as capital gains on shares and real property. Economic income effectively seeks to measure the increase in an individual’s economic resources during a period.
The HWI Project report concludes that the main source of untaxed income included in the ETRs is realised capital gains as well as accrued (i.e., unrealised) gains. The HWI Project group obtained most of their economic income from increases in the value of businesses, property and financial portfolios they own or control. The capital gains from these sources mainly came through increases in the value of businesses they own or control. However it is noted that the economic income gained from businesses, property, and financial portfolios all had a similar impact on lowering their ETRs. In total around 80% of the economic income from the reviewed period was from capital gains.
The research identified that the HWI Project group hold many of their assets in trust, with 67% of the economic income made by the family groups in the HWI Project being made in trusts.
Inland Revenue’s report also noted that the ETR of the families researched varied considerably, depending on how their economic income was gained. There were also variations in the ETR by year, as capital gains are volatile.
Treasury analysis
The Treasury analysis on the ETRs on economic income of the general population, has also been released today. This project models ETRs across the general population based on the Household Economic Survey (“HES”) net worth data from 2018.
Excluding Government paid benefits and including GST paid, this analysis shows a middle wealth New Zealander has an ETR of 20%. The comparable median for the families in the dataset for Inland Revenue’s HWI Project is 9.4%.
It is important to note that there are methodological differences between the Treasury and Inland Revenue projects as they are based on different data sources. The ETRs in Inland Revenue’s research include company and trustee tax, whereas those taxes are not included in the Treasury’s ETR measures.
KPMG observations
Whilst labelled as a HWI research project, it is perhaps more accurate to consider this report an analysis on the impact of not taxing capital gains under the existing tax settings in New Zealand.
Based on the conclusion in Inland Revenue’s report that the ETR paid by middle income New Zealanders is at least double that paid by the wealthier New Zealanders’ in its HWI Project group, the reports appear to be setting the scene for an announcement of tax changes to “level the playing field”. The Minister of Revenue has made it clear that fairness is a fundamental element of any tax system.
In the HWI Project report it is noted that “failing to tax forms of income that are earned predominantly by those who are better off is likely to have an impact in reducing the progressivity of the tax system”.
New Zealand does not have a comprehensive capital gains tax, so the conclusion from Inland Revenue’s report that the main source of untaxed income included in the ETR of the HWI Project group is from accrued and realised capital gains does not come as a surprise. It is also no surprise that the HWI Project group earns significantly larger capital gains that the general New Zealand population.
Indeed, amongst the substantial analysis included in the reports is a table which sets out the mean capital gains on residential real property for the general population as against the survey HWIs. This widely-held asset class provides a pointed illustration of the impact to the ETR calculation when including such gains. In the 2018 tax year, mean gains made by the general population in the highest net worth category totalled approximately $51,992 based on HES data, as compared to approximately $818,446 mean gains made by the HWI group.
There is considerable detail in the reports released today, and before drawing conclusions from the ETRs outlined in the analysis undertaken by both Treasury and Inland Revenue, it is important to understand the methodology and data sources used before drawing conclusions.
In the absence of a broad capital gains tax regime, New Zealand has adopted measures to bring into tax those gains which wouldn’t ordinarily be captured under a standard “income tax” analysis. Included among these measures are the bright-line property rules and the foreign investment fund regime which taxes unrealised gains on foreign investments. Such rules put us out of step with other OECD countries and can create additional challenges for taxpayers. However, there are also significant design complexities involved with introducing a capital gains tax and these challenges need to be taken into consideration.
In its 2019 report, the Tax Working Group (“TWG”) indicated that a lack of information about the impact of current tax settings made it difficult to articulate clearly the trade-offs involved in policy changes or where potential tax gaps existed. The TWG strongly encouraged the Government to release more statistical and aggregated information about the tax system. A lack of data on the distribution of capital gains prevented the TWG from being able to provide precise impacts analysis of extending the taxation of capital gains.
The Inland Revenue and Treasury reports provide some of the information and analysis that was not available to the TWG. Given this, we would not be surprised if the Government reconsiders several of the recommendations made by the TWG including:
- A broad extension of the taxation of capital gains (Recommendation 1)
- Consider increasing the bottom threshold of personal tax to increase the progressivity of the personal tax system (Recommendation 46)
- Consider combining increases in the bottom threshold with an increase in the second marginal tax rate (Recommendation 47)
Although the TWG did not recommend the introduction of a wealth tax (Recommendation 3), given the focus of Inland Revenue’s research, this may still be open for consideration.
Given Inland Revenue’s observation that 67% of the economic income made by the research group in the HWI Project was made in trusts, there is also the possibility that the Government considers changing the 33% tax rate applying to trustee income to align with the top marginal tax rate.
There is considerable detail in the reports released today. Before drawing conclusions from the ETRs outlined in the analysis undertaken by both Treasury and Inland Revenue, it is important to understand the methodology and data sources used. For instance, the Treasury analysis excludes Government paid benefits but includes GST paid. The proportion of GST paid by low to middle income earners will increase their ETRs compared with HWIs, however excluding Government paid benefits such as Working For Families and NZ Super will increase the ETR for lower income earners.
We note that there was also a release last week of analysis on ETRs imposed on incomes of New Zealand residents undertaken by Sapere where different methodology is used to consider ETRs. International research on the ETRs of HWIs is also ongoing.
2023 is an election year. We expect that the findings from Inland Revenue’s HWI Project, in conjunction with the Treasury analysis, may be used by the Government in the upcoming weeks and months to support announcements regarding its tax policies heading into the election.
