NEW ZEALAND TAXATION SUGGESTED SOLUTIONS Chapter 1 Answers. [0001] Question 1 Solution. [0002] Question 2 Solution. [0003] Question 3 Solution

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1 NEW ZEALAND TAXATION SUGGESTED SOLUTIONS 2013 [0001] Question 1 Under a proportionate (or flat) tax rate, the same proportion of income is taken irrespective of the level of income. A constant or flat tax rate is charged to every level of income. Company tax, charged at the rate of 28 per cent, is an example of a proportionate tax rate. A progressive tax rate takes a higher proportion from higher incomes than it does from lower incomes (James, 1998, at 121). Under a progressive income tax, the average rate of tax increases as income increases (IBFD, 2005, at 319). Individual income tax rates are an example of progressive tax rates. The first $14,000 a person earns is taxed at 10.5 per cent; amounts between $14,001 and $48,000 are taxed at 17.5 per cent; amounts between $48,001 and $70,000 are taxed at a higher rate (30 per cent) while income over $70,000 is taxed at an even higher rate (33 per cent). Gift duty was another example of a progressive tax rate in New Zealand. Progressive taxes are a tool used to redistribute money to those on lower incomes. A regressive tax rate takes a decreasing proportion of income as income increases, ie it takes a higher proportion of low incomes than it does from higher incomes. It is argued that New Zealand s goods and services tax (GST), levied at a flat rate and with only a few exclusions, tends to be regressive as those with higher incomes have a greater ability to save rather than spend (and thus escape the full impact of the tax). The lower the income of a taxpayer, the greater is the proportion of their income that they devote to expenditure (and therefore incur GST). Chapter 1 Answers [0002] Question 2 This classification focuses on the nature of the administrative arrangements for assessment and collection of the tax. A direct tax is a tax that is assessed on and (in principle at least) collected from the individuals who are intended to bear it. In contrast, an indirect tax is a tax that is levied on one group with the intention that it be passed on to another group (James, 2012, at 77). Income tax is a direct tax. Self-employed taxpayers and businesses for example are required to file tax returns and pay tax on their income to Inland Revenue. Other examples of direct taxes include capital gains taxes, company tax, and inheritance and wealth taxes. The most common form of indirect taxation is the value added tax (VAT) or the equivalent goods and services tax (GST). Such a tax is levied on businesses involved in the production and distribution of goods and services to consumers. Those businesses add the tax to the price paid by the consumer for the goods and services. The tax, paid by consumers, is therefore collected by the businesses who act as a collection agency. Excise duties, for example on gasoline, stamp duty, and sales tax are other examples of indirect taxes. [0003] Question 3 (1) Income Tax The taxation of income is central to the New Zealand tax system. New Zealand imposes income tax on the worldwide income (with a few exceptions) of all New Zealand residents (as defined) including companies, trusts and individuals. Income tax is also imposed on New Zealand-sourced income derived by non-residents. One of the stated purposes of the ITA

2 0004 New Zealand Taxation 2013 Chapter 1 Answers 2007 (s AA 1) is: to define, and impose tax on, net income (emphasis added). The tax rates for individual taxpayers from 1 October 2010 are as follows (excluding the ACC earner levy): Table 1.1Income Tax Rates Income bracket Tax rate $0 - $14, % $14,001 - $48, % $48,001 - $70, % $70,001 and over 33.0% Companies pay tax at a flat rate of 28 per cent from a company s income year on New Zealandsourced income, irrespective of whether they are resident in New Zealand. Trustee income of trusts is subject to tax at the rate of 33 per cent. Unless the minor beneficiary rule applies, beneficiary income is taxed in the hands of the beneficiary at their marginal rate. Employers are required to withhold tax from the salary and wages paid to employees and forward it to Inland Revenue. This is known as the Pay As You Earn (PAYE) system. In addition, withholding tax deductions are required from certain payments made to self-employed taxpayers. (2) Fringe Benefit Tax Fringe benefit tax (FBT), introduced on 1 April 1985, applies to non-monetary benefits provided by employers to employees and shareholder-employees. Benefits subject to FBT include the provision of a motor vehicle; low interest loans made to employees; free, subsidised, or discounted goods and services; and contributions to some accident, sickness, or death benefit funds. (3) Accident Compensation Insurance Employers and self-employed persons are required to pay levies to cover work-related injuries. The levies payable by these taxpayers depend on the type of business conducted, the inherent risk of injury in that activity and the earnings of employees. In addition, employees and self-employed persons pay the earner levy to cover non-work related injuries. For employees, the earner levy is deducted from their employment income, together with PAYE. (4) Capital Gains Tax New Zealand does not have a comprehensive capital gains tax (CGT); rather certain types of gains that would normally be capital profits (and not taxable) are specifically deemed to be income. Examples of these deeming sections are ss CB 6 to CB 23 which tax certain gains from the sale of real property, and ss CB 4 and CB 5 which similarly tax gains from certain personal property sales (for example shares). There are also specific rules, including the financial arrangements rules, which also blur the capital/revenue distinction. (5) Goods and Services Tax The goods and services tax (GST) was introduced with effect from 1 October The tax is a broad based consumption tax levied at the rate of 15 per cent on goods and services supplied in New Zealand by a registered person in the course of a taxable activity. [0004] Question 4 A person deriving gross income of $80,000 would pay tax of $17,320, calculated as follows: $0 - $14, % = $1,470 $14,001 - $48, % = $5,950 $48,001 - $70, % = $6,600 $70,001 - $80, % = $3,300 A company deriving gross income of $80,000 would pay tax of $22,400, calculated at the flat rate of 28 pe cent. [0005] Question 5 (i) A higher court when considering a case may conclude that the decision of an earlier lower court was wrong and overrule the earlier case. The decision in the earlier case (as far as the parties to that dispute are concerned) remains. However, future courts will not be required to follow that earlier case (ii) Where a case has different material facts from an earlier decision, that earlier case will be distinguished and the court in the later case Brookers 2

3 Chapter 1 Answers New Zealand Taxation will not be obliged to follow it even if it was a decision from a higher court. [0006] Question 6 A wide range of issues need to be considered including: How much revenue is required by the government to implement its social and economic policies? Who will collect the taxes and administer the tax system? Is it important that administrative and compliance costs of the tax system are minimised? If so, how is this to be achieved? Should there be a mix of direct tax (eg income tax) and indirect tax (eg a consumption tax)? If so, what is the appropriate proportion of each tax type? Will individuals, companies, trusts, and other entities be taxed at the same or different rates? If there is income tax, should it be levied at a progressive or proportionate rate? If there are progressive rates, what income threshold(s) should the higher rates be imposed on? What should those income tax rates be? If a consumption tax is introduced, at what rate should the tax be levied at? Should there be exemptions for basic items such as food and clothing items? Should there be a tax on capital gains? If so, at what rate(s) should the tax be levied? Should there be exemptions for private residences and/or a threshold below which no capital gains tax is levied? Should alternative taxes be considered given the nature of the Tulgravian economy? For example should a bed tax, charged on hotel beds, be levied? A resolution of these issues requires some policy matters to be resolved. Specifically, the principles of a good tax system need to be considered. Recognising that there is a trade-off between the principles of a good tax, which of the principles are more important to the Principality of Tulgravia? For example: If horizontal and vertical equity are considered most important, then the tax system will require a comprehensive capital gains tax and progressive income tax rates. While the principle of equity may be satisfied such a system will impose high compliance costs on taxpayers (especially through the capital gains tax) and high progressive rates may reduce compliance and encourage tax avoidance. Alternatively, if simplicity (and reducing compliance and administrative costs) is most important, there could be a 10 per cent income tax levied on all people. While this would be relatively simple it would not recognise the ability-to-pay aspect of equity. Those on higher incomes have a greater ability to pay tax and should proportionately bear a higher tax burden, according to Adam Smith. If the ideal is a tax system that is neutral (ie, does not impact on the choices made by taxpayers), this could be achieved by a comprehensive consumption tax (GST) levied with no exemptions. While such a tax would also be certain, it would regressive and therefore would not be vertically equitable. [0007] Question 7 The doctrine of precedent is (Webb, Sanders and Scott, 2010, at 389): a body of rules which provides guidelines as to when a particular Court will be obliged (bound) to follow the decision of an earlier Court, and when it is at liberty to ignore or overrule it. The doctrine, also known as stare decisis, which is based on the notion of consistency, is one of the key foundations in the development of case law and relies on a court hierarchy. According to the doctrine, a court is obliged to follow an earlier decision of a court higher in the same hierarchy (where the ratio of the earlier case is applicable), and is never obliged to follow the decision of a court which is lower in that hierarchy. The doctrine applies as follows: The TRA (and District Courts generally) must follow the decisions of the High Court, Court of Appeal and Supreme Court. The TRA and the District Courts may depart from their own earlier decisions, although typically they will follow those decisions where possible. Brookers 3

4 0008 New Zealand Taxation 2013 Chapter 1 Answers The High Court must follow the decisions of the Court of Appeal and Supreme Court. The High Court may depart from its own earlier decisions, although usually the court will follow those prior decisions where possible. The Court of Appeal must follow decisions of the Supreme Court. In the past, where there have been good reasons, the Court of Appeal has departed from an earlier Court of Appeal decision. The Privy Council is not bound by the decisions of any lower court. In addition, it is not bound to follow its own decisions. Previously when hearing cases appealed from the New Zealand Court of Appeal, the Privy Council acted as the highest court in the New Zealand hierarchy. Its decisions therefore bound all New Zealand (lower) courts. Webb, Sanders and Scott (2010, at 399) suggest that: where... a Privy Council decision did bind New Zealand courts, it will continue to do so until the issue comes before the Supreme Court. The Court of Appeal has treated New Zealand Privy Council decisions as binding. The Supreme Court now occupies the highest place in New Zealand s court hierarchy. In Couch v The Attorney General [2010] NZSC 27, the members of the Supreme Court held that the court has the jurisdiction to depart from a decision of its own, or of the Privy Council (Webb, Sanders and Scott, 2010, at 263, ). However, the judgment in that case is tempered with caution as to when such departures should occur. Decisions of courts in other countries, while not binding on the New Zealand courts, may nevertheless also be useful in assisting the court in reaching a conclusion concerning a particular issue, especially for example if there is no New Zealand statute or case on the matter. Such decisions are said to be persuasive as distinct from binding. How persuasive a decision is will depend on the similarity of the relevant legal principles in the overseas jurisdiction and the place that the foreign court occupies in its hierarchy, as higher courts normally will have the most senior judges sitting on them. Judgments of the High Court of Australia, the House of Lords (United Kingdom), Privy Council and English Court of Appeal are highly regarded. [0008] Question 8 Under the purposive approach, the courts aim to give effect to the intention (purpose) of Parliament (as expressed in legislation). In applying this approach, the first step is to discern the purpose of the legislation. At times the natural and ordinary (literal) meaning of words will accord with the intention of Parliament. When this is not the case a wider inquiry will be required. However, Webb, Sanders and Scott (2010, at 334) comment that: [a] purposive approach can only be used as an aid in interpreting the meaning of the words of a provision. It cannot be used to create provisions that do not exist If the legislature has failed to cover some eventuality, or has used words that are at odds with the intent of the rest of the Act, it will not be open to the court to disregard the plain language of the statute and alter the meaning of those words. The purposive approach is endorsed by s 5(1) of the Interpretation Act 1999 which states that: The meaning of an enactment must be ascertained from its text and in the light of its purpose. (emphasis added) In determining the purpose of Parliament the courts will look to: Other provisions in the relevant Act including the table of contents, headings to Parts and sections, examples, interpretation sections, diagrams and any purpose or object provisions (eg, ss AA 1 and BA 1 of the ITA 2007). Section 5(3) of the Interpretation Act 1999 also outlines indicators within an Act that can be used for interpretation. Related legislation and other more general statutes including the Interpretation Act 1999, and New Zealand Bill of Rights Act Other external aids including international treaties, the Treaty of Waitangi, parliamentary debates and materials, select committee reports, etc. The courts will also consider the common law when interpreting a statute. Should the common law conflict with the statute then the statute will prevail. The New Zealand (and English) courts have also referred to the scheme and purpose approach to interpretation. See for example Richardson J in Challenge Corporation v Commissioner of Inland Revenue [1986] 2 NZLR 513 (CA) at 549. The scheme of the Act refers to the Brookers 4

5 Chapter 1 Answers New Zealand Taxation structure of the Act as a whole and the relationship between the various provisions. Underlying this term is the presumption that there are common threads or themes that run through the Act and therefore it can be assumed when interpreting sections in an Act that, as far as possible, they should be consistent with each other. The scheme of the Act can indicate the common purpose(s) of the legislation. This approach is again consistent with s 5(1) of the Interpretation Act 1999, which refers to ascertaining a statute meaning in the light of its purpose. The courts have also developed presumptions of construction when interpreting legislation. The ITA 2007 has a purpose provision, s AA 1, which provides that the main purposes of the Act are to: Define, and impose tax on, net income; Impose obligations concerning tax; and Set out rules for calculating tax and for satisfying the obligations imposed. Brookers 5