On 11 March 2020, the World Health Organisation declared a global pandemic, as a result of the outbreak and spread of COVID-19, which has impacted the global economy and created uncertainty in global markets and valuations.
In response to the impact of COVID-19, the New Zealand Government has taken a number of actions to support the wellbeing of New Zealanders and the New Zealand economy, including the introduction of a Small Business Cashflow (loan) Scheme and the COVID-19 Resurgence Support Payment scheme administered by Inland Revenue.
More than a year has passed since March 2020 and the New Zealand economy is stronger than initially predicted. However, COVID-19 still presents some uncertainty and challenges for New Zealand as a whole. A summary of the key impacts on the non-departmental financial schedules is set out below.
Tax revenue for the 2020-21 financial year is based on the revenue recognition methodology disclosed in note 3. While most revenue is recognised in cash in the same financial year, these financial schedules include tax estimates and assessments that are not due to be paid until after 30 June 2021. The amount owing is reported in receivables (refer note 4).
Estimation of tax revenue affects mainly income tax for companies and other persons. Accruing income tax revenue requires a significant degree of estimation compared to other tax revenue such as GST and source deductions (for example PAYE). While most taxpayers pay annual income tax in instalments using the provisional tax regime, final income tax owed, or tax refunds due, for a year is only known with reasonable certainty when the taxpayer files a terminal tax assessment for that period. For GST and source deductions, estimations are relatively certain because taxpayer filing dates are so regular and frequent.
Most tax is paid on a payday or monthly basis. Therefore, the impacts of COVID-19 are recognised at the time of filing, with no need to change our revenue recognition policies. The exception is income tax for companies and other persons, where tax returns are filed in the future.
The impact of COVID-19 on economic activity - through alert levels, border restrictions and lockdowns - has continued to have flow-on impacts to tax revenue in 2020-21, compared to a level of economic downturn that was expected when ‘The Estimates of Appropriations for the Government of New Zealand for the year ending 30 June 2021’ were prepared (including updates made for late-breaking Government decisions, particularly in relation to COVID-19 pandemic relief measures).
Taxation revenue was $93.792 billion in 2020-21, an increase of $16.135 billion (20.78%) compared to 2019-20, and $21.606 billion higher than The Estimates of Appropriations for the Government of New Zealand for the year ending 30 June 2021. The New Zealand economy has performed stronger than initially predicted. As a result, the rates of employment growth, wage growth, business profits, taxable incomes, provisional tax estimates, consumption and residential investment have all been significantly higher than forecast.
Tax revenue - income tax for companies and other persons
In 2019-20, we updated our tax estimation methodology to reflect the estimated impact on tax revenue. This was required because income tax is an annual tax and the impact of COVID-19 will not be known until taxpayers file their annual terminal tax assessments in the future. COVID-19 is expected to continue to have an impact on taxable income earned by companies and other persons.
Where taxpayers subject to the provisional tax regime have not yet filed a terminal tax assessment for the period, provisional tax assessments are recognised based on the provisional tax method adopted by the taxpayers. These provisional tax assessments are based on 105% of the prior year terminal tax. This method suits a large number of taxpayers who generally expect to make more or roughly the same amount of profit in a coming tax year.
After the global pandemic was announced, the 105% assumption was not considered appropriate for the estimation of income tax revenue for the financial year ended 30 June 2020. As a result, we estimated income tax revenue based on the Treasury’s most recent macroeconomic forecasts, using the percentage movement in forecasts of firms’ net operating surplus (The Treasury is no longer routinely publishing operating surplus forecasts, but will release operating surplus forecasts on request). The firms’ net operating surplus is a component of Income GDP and is designed to measure net profits of businesses. This measure is approximately equal to accounting profit before taxes, dividends and interest, but after depreciation. It was the most appropriate assumption to determine taxable income.
In preparation for the 2020-21 year, we have sought to test the appropriateness of this measure. Our analysis shows that this firms’ net operating surplus measure is a more appropriate methodology to estimate income tax revenue than the 105% assumption, and hence we will continue to use this methodology going forward. However, we have also identified that we may need to adjust it for any material impacts that are not included in the most recent Treasury forecasts.
As a result, for 2020-21 and onwards, the revenue estimation process will be based on a rebuttable presumption that the forecast of firms’ net operating surplus, from the most recent Treasury forecast, is used as the uplift assumption, unless rebutted for material impacts.
Applying the Treasury and Stats NZ firms’ net operating surplus forecasts, (rather than the previous uplift of 105%), has resulted in a downward adjustment of $346 million to tax revenue. This is made up of $219 million gross companies tax revenue and $127 million other persons revenue.
The updated revenue recognition methodology for income tax is disclosed in note 3.
Tax receivables - past due
Past due debt has increased in 2020-21 by $136 million (3.2%) to $4.384 billion. This growth is smaller than in 2019-20, when the past due debt increased by $726 million (21%).
During 2019-20, Inland Revenue made prioritisation decisions to redeploy staff from debt collection to other functions to manage the large and complex requirements of delivering Release 4 of our transformation programme, and to support our customers as they continue to familiarise themselves with our new systems and processes.
This prioritisation and the impacts of COVID-19 on our customers resulted in an increase in the debt levels and a reduction in debt repayments.
However, in the 2020-21 year, there has been a strong continued focus on supporting our customers through COVID-19, including working with those in debt to set up instalment arrangements and applying new legislative powers to remit penalties and interest where possible.
Despite an increase in past due debt, we have seen a stronger collectability of debt this year. This has resulted in a reduction in the average impairment of tax debt.
Note 4 provides more information on the gross value and fair value of tax receivables, and the significant assumptions and sensitivities behind the fair value.
Small Business Cashflow (loan) Scheme
In response to COVID-19, the Government has made Small Business Cashflow Scheme loans available to eligible small-to-medium-sized businesses. During the 2020-21 year, this scheme was extended from 31 December 2020 to 31 December 2023 and the loans are interest-free if paid back within two years (previously it was within 1 year).
In the 2020-21 financial year, a further $298 million (2020: $1,428 million) has been disbursed and a further $112 million (2020: $5 million) has been repaid. The fair value of the loans as at 30 June 2021 is $921 million.
The most critical assumption for determining the fair value is the default rate of the loans, which informs the initial fair value write-down of the loans. The initial fair value write-down on total loans of $828 million is due to these unsecured loans being made available to businesses severely impacted by COVID-19 at below market rates and with other favourable terms.
Note 6 provides more information on the scheme, the valuation model and the significant assumptions and sensitivities behind the fair value.
The fair value of the Student Loan Scheme at 30 June 2021 is $10.841 billion, a net increase of $447 million (4.3%). The most notable change this year is the $745 million fair value remeasurement gain (2020: $97 million loss).
The fair value remeasurement gain is largely due to changes in discount rates, risk premiums and macroeconomic forecasts since the Budget Economic and Fiscal Update 2020, as well as positive increases because the initial valuation data indicates that COVID-19 is having less negative impact than initially modelled.
The discount rates have increased the value of the scheme by $221 million (2020: $343 million). This is largely due to changes in risk free and risk premium rates. The market spreads have been gradually reducing back to pre-COVID-19 levels. Adjustments for the impact of COVID-19 increase the fair value by $230 million (2020: $507 million decrease), of which $103 million is due to updating modelling assumptions for employment and $106 million relates to updated assumptions for salaries.
Since the June 2020 valuation, more data on overseas repayments has been available to assist with reviewing the COVID-19 allowances. In summary, the New Zealand economy has shown remarkable resilience to date.
In terms of unemployment, there are specific regions and industries that have suffered more than others. On aggregate, the previously assumed spike in unemployment has not materialised to date and the Treasury does not expect this spike to happen in the latest forecasts.
The Treasury’s expectations around when border restrictions will ease, and for when net migration will return to pre-COVID-19 levels (migration is assumed to return to its normal patterns from 1 April 2022), remain unchanged.
Finally, for overseas repayments, the latest experience is also positive in that we have not seen a decline or any evidence of deterioration in overseas compliance so far.
Note 7 provides more information on the student loan scheme, the valuation model and the significant assumptions and sensitivities behind the fair value.