Why it is important to align the personal and trust rates

John Hartevelt reports:

A $300 million tax dodge – by which half the country’s rich don’t pay the top tax rate – will be cracked by changes tipped for tomorrow’s Budget.

Prime Minister John Key said yesterday that tax-avoidance loopholes were being targeted.

The top income tax rate of 38 per cent has encouraged wealthy Kiwis to move their money into family trusts, which pay tax at 33 per cent, or into companies, which attract only 30 per cent tax.

An Inland Revenue sample of 100 of the wealthiest New Zealanders showed that only about half were paying the highest marginal tax rate on their income.

The Tax Working Group says sheltering of income in trusts cost the Government about $300m in tax revenue in 2007.

John Shewan, chairman of PricewaterhouseCoopers and a working group member, said trusts were “breeding like rabbits in the South Island”.

That is a key point to remember – many wealthy people are avoiding the 38% tax rate. And if they have rental property investments, they will probably end up paying more in overall taxation.

“And that’s what happens when you have silly tax rules that provide that incentive. The tax rules have driven people into using companies and trusts.

“People aren’t stupid. The shockingly poorly designed tax package of 2000 has caused all sorts of things to happen.”

Financial author Martin Hawes said he would be surprised if any of the richest Kiwis paid the top income tax rate and, if they did, it would be on only a tiny fraction of their worth.

The lower the tax rates are, the less people try to avoid them.

Mr Key said the Budget would include “a number of areas” in which tax liability was increased.

“You will see we’ve done quite a good job actually of closing down loopholes and making sure there is fairness in the system,” he said.

“We know that roughly half the people on the rich list actually didn’t pay the top personal rate last year, so [we’re trying to] get some fairness into the system.”

Mr Shewan said “a great number of wealthy people” would end up paying more tax.

“There is political risk associated with increasing anybody’s tax and some people are not going to be happy with the statements that are going to be made on Budget night.”

Mr Hawes said business people and farmers were among the most common users of family trusts.

“On the tax side, the people who would be affected by any tax changes to trusts will be National Party voters.”

And again it is not about redistributing a small cake. It is about growing a larger cake. Less inventive to avoid tax through trusts and residential property investment. Greater incentive to earn more and save more and invest more in capital markets.