KiwiSaver tax dodgers may have got away with $200m-plus reward
Thursday, 6 June 2019
OPINION A back-of-the-envelope calculation suggests that Inland Revenue may have chosen to forgo at least $200 million by not pursuing historical tax avoidance on KiwiSaver accounts, mostly by taxpayers on higher incomes.
That is despite knowing who is likely to have underpaid that tax, and how.
In my view, Inland Revenue's decision not to attempt to collect that unpaid tax is best described as a political decision, rather than a 'business decision' as the department has claimed.
But I am not going to pretend that the dilemma Inland Revenue has faced is easy.
**READ MORE:
* Huge numbers who underpaid tax on KiwiSaver last year 'off the hook' for previous years
* 450,000 people have been paying wrong rate of tax on KiwiSaver and other investments, IRD discovers
For those new to the KiwiSaver conundrum, the background is as follows.
Inland Revenue upgraded its tax system in April and in the course of that discovered that 450,000 people had selected the wrong rate of tax (PIR) on KiwiSaver and other investment accounts known as PIEs.
Basically, in the course of moving to a more accurate and fair tax system, it uncovered a massive skeleton in the cupboard.
The department has so far declined to say what proportion of those 450,000 people were paying too higher rate of tax, and what proportion had declared too low a PIR, or how much tax was underpaid.
But comments from Inland Revenue and some KiwiSaver providers, as well as feedback from Stuff readers, combine to point to the majority of those 450,000 people paying too little tax by selecting a 10.5 per cent or 17.5 percent PIR, when they should have been on the 28 per cent rate.
Inland Revenue is requesting underpayers pay the tax they avoided in the 2018-19 year, and several people have reported getting unexpected tax bills of hundreds of dollars as a result.
But the department has also made it clear it does not intend to go back through its records to see if those people had also underpaid tax on their investments by selecting too low a PIR in previous years.
That was a very big call that will in some cases reward tax cheats.
Many of the people who underpaid tax will have made honest mistakes, but others are likely to have intentionally declared too low a PIR.
I suspect there will also be a big group who lie somewhere in the middle.
These will include people who moved up through income bands over recent years and who may have had it in the back of their minds that they should check if they were still paying the right rate of tax on their investments, but who for one reason or another didn't get around to it.
Now for that back-of-the-envelope calculation.
My first big assumptions are that about three-quarters of the 450,000 people declared too low a rate of PIR last year, and (conservatively, I'd think) that those people will have also been underpaying tax for an average of four years prior to 2018-19.
I am also assuming that they declared an average PIR of 13 per cent, so a mix of the 10.5 per cent and 17.5 per cent rates.
Inland Revenue would in most cases be able to tax the undertaxed income at 33 per cent if they had pursued those taxpayers, because that is the rate people have to pay in income tax on their investment income if they declare too low a PIR.
The total amount of money in KiwiSaver averaged about $35b during the the four years prior to 2018 and so – based on an approximate average annual rate of return of 5 per cent – the average taxable gains over that period would be about $7b.
There are 2.8 million KiwiSavers in total, so if Inland Revenue could have collected 20 per cent tax on three-quarters of 450,000 'average KiwiSavers' who underpaid tax over four years, it could have expected to net about $170m.
But of course the people avoiding tax would not all have been average KiwiSavers; most will have been full-time workers on higher incomes because by definition they were all avoiding the higher rates of PIR.
Based on that, I reckon it may be fair to assume Inland Revenue has instead waved goodbye to $200m to $500m of avoided tax.
Inland Revenue will presumably have its own estimate since – remember – it said it had made a 'business decision' not to chase after that money.
But it is currently declining to release that estimate, preferring instead to ask for an Official Information Act request for that information, which means it may not supply any figure until after the controversy has died down, if at all.
I did also give it the opportunity to comment on my $200m to $500m 'guesstimate'.
Right, wrong, 'way-out', close perhaps?
Inland Revenue spokesman Rowan McArthur was thankful for the opportunity to comment.
But he said it just wanted to reiterate its decision that it had decided its resources should be 'devoted to moving forward from this tax year, confident in the improved information and processes the new system gives us, rather than attempt to track down every possible instance of error by people in past years'.
To put it all in context, Victoria University estimated the Government lost just over $30m to welfare fraud in 2014.
Of course, Inland Revenue is in a no-win position and, to be honest, I'm not saying I would necessarily have made a different call.
By deciding not to go after any historical underpayments, Inland Revenue risks briefly infuriating the majority of taxpayers who paid the right amount of tax on their investments and sending the message that breaking the rules – wittingly or unwittingly – can pay.
But if it did chase after all the historical debt, some people – some of whom will have made honest mistakes – would be faced with unexpected tax bills that would in many cases run into thousands of dollars that they might not all be easily able to pay.
That is something those taxpayers would be likely to remember for much longer and that could have generated enormous negative publicity.
These are the issues that I believe will have really been weighing on Inland Revenue's minds when it made its 'business decision'.
Revenue Minister Stuart Nash has effectively pulled down the shutters, characterising this as an operational matter for Inland Revenue.
If making a call not to pursue what would be an easy chase for perhaps hundreds of millions of dollars of avoided tax really is a purely operational matter for Inland Revenue, it would be interesting to see what the big policy issues were in his inbox right now.
Some Stuff readers have made an interesting suggestion that the fair outcome would be for Inland Revenue to pursue the underpaid tax, but to take it from people's investment balances so they had time to absorb the hit, rather than demanding they immediately pay up in cash.
Fair perhaps, but not easy from an administrative or legal perspective.
There are other aspects to this saga.
While it has always been up to individuals to check they have selected the right PIR, should KiwiSaver providers have done more to head off that massive level of tax non-compliance?
Could providers have been conflicted by the fact that they stand to gain extra fee income if their clients are paying less in tax on their investments than they should?
And what about the unknown proportion of the 450,000 people who have been paying too much tax on their KiwiSaver accounts and other PIE investments and who are not, by the nature of that tax, allowed to claim any refunds?
They will be on incomes below $48,000.
Is it fair that they have been incorrectly taxed 28 per cent on their investment incomes with no redress, especially now it is known that higher earners will get away with paying 17.5 per cent or even 10.5 per cent tax on their historical investment income?
No wonder Inland Revenue is keen to just move on.