Personal tax cuts

Sections CS 1, HM 58, LC 3, LC 4, ML 2(1), RC 5(4), RC 8(9), RC 10(3)(a), RC 11(4), RD 50 to 53, RD 58 to 61, RZ 3 to RZ 5C, YA 1, schedule 1, part A, table 1, schedule 1, part C, table 1, schedule 1, part D, tables 1 to 5, schedule 2, part A, schedule 2, part B, table 1, schedule 4, part I, schedule 6, tables 1 and 2 of the Income Tax Act 2007; sections 28C and 33C(c) of the Tax Administration Act 1994

Under changes enacted in the Taxation (Budget Measures) Act 2010, personal income tax rates are being reduced from 1 October 2010.

To ensure that the effects of the tax cuts flow through the tax system appropriately, other consequential amendments to the tax Acts have been made. The Taxation (Budget Measures) Act 2010 therefore amends fringe benefit tax rates, secondary employment codes, withholding tax rates for casual agricultural employees and election day workers, extra pay rates, employer superannuation contribution tax rates, portfolio investment entity rates, resident withholding tax rates, retirement superannuation tax rates, withholding rates for some Māori authority distributions, ACC attendant care withholding rates, child taxpayer tax credits and transitional circumstances tax credits. Transitional provisional tax rules for individual taxpayers are also provided.

Redundancy payment tax credits are being removed from 1 October 2010 and officials have recommended that fund withdrawal tax be repealed from 1 April 2011.

Key features

The Income Tax Act 2007 and the Tax Administration Act 1994 have been amended to provide for tax cuts for individuals from 1 October 2010. The main features of the changes are:

• The new tax rates apply to income earned by individuals from 1 October 2010.
• The bottom tax rate will be lowered from 12.5% to 10.5%, the 21% rate to 17.5%, the 33% rate to 30%, and the highest rate lowered from 38% to 33%.
• Consequential changes to other aspects of the tax legislation - such as PAYE and provisional tax, resident withholding tax rates for interest income, portfolio investment entity tax rates, and fringe benefit tax - will be made to coincide with these changes.
• Some withholding tax rates remain unchanged (for example, the 19.5% tax rate for Māori authorities, the tax rate for non-resident seasonal workers and certain withholding tax rates such as payments to horticultural contractors). These rates will be reviewed at a later date as it is not yet clear what rates would be appropriate for these payments.

Application dates

The changes generally apply from 1 October 2010.

The new composite income tax rates apply for the 2010-11 income year.

Officials have recommended that fund withdrawal tax be repealed from 1 April 2011.

Detailed analysis

Composite income tax rates for the 2010-11 income year (schedule 1, part A, table 1 of the Income Tax Act 2007)

Income tax is calculated based on a person's annual income. Because the tax rates are changing part-way through the 2010-11 income year, the new tax rates that apply for the whole of the 2010-11 income year are "composite tax rates" that reflect an average of the two income tax rates that are used during the year. The table below shows the income tax rates to be used during the 2010-11 income year as well as the composite tax rates for the year. The new composite rates are contained in schedule 1, part A, table 1 of the Income Tax Act 2007.

Income tax rates and composite tax rates for 2010-11 income year

Income tax rates for the 2011-12 and future income years (schedule 1, part A, table 1 of the Income Tax Act 2007)

Schedule 1, part A, table 1 of the Income Tax Act 2007 provides for new income tax rates for the 2011-12 and future income years.

Income tax rates for the 2011-12 and future income years

PAYE rates: M and ML tax codes

The new income tax rates apply to PAYE for the first pay period that ends on or after 1 October 2010. For pay periods that span the 1 October date and are for one month or less, PAYE should be deducted at the new rates. If the pay period spanning 1 October is longer than a month, PAYE should be deducted at the old rate for the portion of the pay period before 1 October and at the new rate for the portion of the pay period after 1 October.

PAYE rates from 1 October 2010

Inland Revenue's PAYE deduction tables will be updated so the M and ML tax codes reflect the new rates.

PAYE rates: Secondary employment income (schedule 2, part A of the Income Tax Act 2007)

Schedule 2, part A of the Income Tax Act 2007 reduces withholding tax rates on secondary employment income to reflect the new tax rates. This applies from the first pay period that ends on or after 1 October 2010.

PAYE rates from 1 October 2010: Secondary employment income

Extra pays (schedule 2, part B, table 1 of the Income Tax Act 2007)

Lump sums earned in the course of employment ("extra pays") are generally taxed at the employee's marginal rate. Schedule 2, part B, table 1 of the Income Tax Act 2007 will reduce withholding tax rates on extra pays to reflect the new marginal tax rates. These will apply from the first pay period that ends on or after 1 October 2010.

Tax rates for extra pays

PAYE rates: Casual agricultural employees and election day workers (schedule 2, part A of the Income Tax Act 2007)

Schedule 2, part A of the Income Tax Act 2007 reduces withholding tax rates for casual agricultural employees and election day workers. The rate is dropping from 21% to 17.5%, to reflect the second-to-lowest marginal tax rate and applies from the first pay period that ends on or after 1 October 2010.

Resident withholding tax rates on interest income for individuals (schedule 1, part D, table 2 of the Income Tax Act 2007)

Schedule 1, part D, table 2 of the Income Tax Act 2007 provides for new resident withholding tax (RWT) rates for individuals who receive interest income. These reflect the new personal tax rates of 33%, 30%, 17.5% and 10.5%.

Row 1 of schedule 1, part D, table 2 replaces the previous 38% RWT rate that applied if a person had not supplied their interest payer with their tax file number with a 33% rate, to align with the new highest marginal tax rate.

Row 2 of schedule 1, part D, table 2 introduces a new 33% default rate from 1 October 2010 for people who have opened a new account with an interest payer after 31 March 2010 but do not elect a tax rate.

Row 5 of schedule 1, part D, table 2 provides for a 17.5% default rate from 1 October 2010 for people who have not opened a new account after 31 March 2010 and have not made a tax rate election.

Additionally, table 2 sets out transitional rules so that people who elected rates before 1 October 2010 shift automatically on that date to the relevant new RWT rates.

The new rates apply from 1 October 2010.

Consequential change to resident withholding tax rates on interest income for companies (schedule 1, part D, table 3 of the Income Tax Act 2007)

Schedule 1, part D, table 3, rows 3 and 4 have been amended to reflect changes to personal income tax rates. This reduces the rate of resident withholding tax from 38% to 33% for interest paid to a company when the recipient of the interest has either elected for the top personal rate to apply or has not supplied their tax file number to the payer.

The change applies from 1 October 2010.

Portfolio investment entity (PIE) rates (sections HM 58, YA 1 and schedule 6, table 1 of the Income Tax Act 2007)

Schedule 6, table 1 has been amended to lower the tax rates that apply to investors in portfolio investment entities (PIEs).

PIE tax rates

Section HM 58 ensures that people who invest in PIEs before 1 October 2010 will automatically shift to the new equivalent rate on 1 October 2010, so that they do not need to re-elect their rate with the PIE.

The changes apply from 1 October 2010.

Provisional tax (sections RZ 3 to RZ 5C and YA 1 of the Income Tax Act 2007)

Changes to sections RZ 3 to RZ 5 amend the formulas used to calculate provisional tax and allow individuals who pay provisional tax based on the earlier year method to reduce their provisional tax payments from 1 October 2010.

To calculate provisional tax from 1 October 2010 that is paid on the basis of an earlier year's residual income tax (RIT), transitional factors apply.

The following table provides adjustments to the transitional factors for individuals on the standard and the GST ratio methods for calculating provisional tax for the 2010-11 or later income years.

Adjustments to transitional factors for calculating provisional tax for the 2010-11 or later income years

For the 2010-11 income year the adjustments apply to provisional tax payments made on or after 1 October 2010.

Consequently, the formulas referred to in sections RZ 5B and RZ 5C from the 2008 Budget measures have been repealed.

New FBT rates (sections RD 50 to 53, RD 58 to 61, and schedule 1, part C, table 1 of the Income Tax Act 2007)

Changes to sections RD 50 to 53 and schedule 1, part C, table 1 of the Income Tax Act 2007 provide for new fringe benefit tax (FBT) rates and thresholds for fringe benefits. These reflect the new personal tax rates. The changes apply to the 2010-11 income year and subsequent income years. For the 2010-11 income year, composite rates apply for attribution purposes to reflect the two sets of rates being used for that year.

FBT rates and thresholds for attribution purposes

Employers still have the option of paying FBT at a single rate if they prefer. Changes to sections RD 58 to 61 reduce the single rate from 61% to 49.25%. For close companies and small businesses that are able to file FBT returns annually, the applicable rate is also reduced to 49.25% from the 2011-12 income year. For the 2010-11 income year, however, a composite rate of 55.04% will apply.

New employer superannuation contribution tax rates (schedule 1, part D, table 1 of the Income Tax Act 2007)

Contributions that an employer makes to an employee's superannuation scheme are generally taxed at the employee's marginal tax rate under the employer superannuation contribution tax (ESCT) rules. Schedule 1, part D, table 1 of the Income Tax Act 2007 provides for new ESCT rates. The 12.5% rate drops to 10.5% and the 21% rate drops to 17.5%. The rate reduces from 33% to 30% for people who earn between $57,601 and $84,000.

The changes apply from the first pay period that ends on or after 1 October 2010.

ESCT rates

It should be noted that the income ranges at which the ESCT rates apply are higher than the income ranges that apply for personal tax rates. This is to reduce the risk that employer contributions made to employees whose income is close to a threshold are not overtaxed.

New retirement superannuation contribution tax rates (schedule 1, part D, table 5 and schedule 6, table 2 of the Income Tax Act 2007; section 28C of the Tax Administration Act 1994)

Certain entities make contributions to a superannuation scheme for the benefit of their individual members under the retirement superannuation contribution tax (RSCT) rules. These contributions are generally taxed at the member's marginal rate. Schedule 1, part D, table 5 and schedule 6, table 2 of the Income Tax Act 2007 provide for new RSCT rates that reflect the new personal tax rates.

A consequential change has also been made to section 28C of the Tax Administration Act 1994, which deals with notification of a person's retirement scheme prescribed rate, to reflect the new top tax rate.

The changes apply from 1 October 2010.

ACC attendant carers (schedule 4, part I of the Income Tax Act 2007; section 33C(c) of the Tax Administration Act 1994)

Payments to ACC attendant carers are currently subject to a withholding tax rate of 12.5%, which reflects the lowest tax rate. Schedule 4, part I, clause 1 reduces the withholding tax rate to 10.5% from 1 October 2010. A consequential change has also been made to section 33C(c) of the Tax Administration Act 1994. This ensures that these taxpayers do not need to file a tax return if they used either the 10.5% or the 12.5% rate in the 2010-11 income year.

Payments from Māori authorities to members who have not provided a tax file number (schedule 1, part D, table 4 of the Income Tax Act 2007)

The current rate of tax for Māori authority distributions to members who have not provided a tax file number is 38% in schedule 1, part D, table 4, row 2. This rate has been reduced to 33% to reflect the reduction in the top personal tax rate.

The changes apply for payments made on or after 1 October 2010.

Fund withdrawal tax (section CS 1)

Fund withdrawal tax (FWT) is a 4.2% tax payable on some superannuation fund withdrawals for members whose income is above $70,000. FWT was introduced to ensure that taxpayers who are on the highest tax rate (which is generally 38% until 1 October 2010) were not undertaxed under the employer contribution superannuation tax (ESCT) rules, as the top rate for ESCT was 33%.

As a consequence of the new legislation's alignment of the top ESCT rate and the top personal tax rate, fund withdrawal tax was to be phased out so that it would not apply to contributions made after 1 October 2010.

However, officials have instead recommended that fund withdrawal tax be repealed on all withdrawals from 1 April 2011, which is the date from which there is no discrepancy between the top ESCT rate and the top actual tax rate. This will be included in a future bill.

Child taxpayer credit (section LC 3 of the Income Tax Act 2007)

The child taxpayer credit provides children with a tax rebate on income that is not from interest or dividends. This allows an eligible child to earn income (less interest and dividends) up to $2,340 a year tax-free.

As a result of the reduction in the lowest tax rate from 12.5% to 10.5%, section LC 3 of the Income Tax Act 2007 has been consequentially amended so that the current tax-free threshold stays at the same level.

The changes apply to the 2010-11 and later income years.

Transitional circumstances credit (section LC 4 of the Income Tax Act 2007)

The transitional circumstances credit effectively provides a tax-free threshold of $5,824. It is available for some people who earn under $9,880. As a result of the reduction in the lowest tax rate from 12.5% to 10.5%, section LC 4 of the Income Tax Act 2007 has been consequentially amended so that the current tax-free threshold stays at the same level.

The changes apply to the 2010-11 and later income years.

Redundancy tax credit (section ML 2(1) of the Income Tax Act 2007)

Section ML 2(1) has been amended to remove the redundancy tax credit from 1 October 2010. The redundancy tax credit was originally introduced to ensure that the receipt of a redundancy payment did not cause a person to move up a tax threshold and be taxed at a significantly higher tax rate than they would ordinarily. (The top personal tax rate at the time was 39%, which was 6% higher than the next highest personal tax rate at the time. The 39% rate has since been reduced to 38%.) Because the 38% rate is reduced to 33% from 1 October, and because there is a smaller gap between the new 33% top personal tax rate and the next lowest rate of 30%, this credit is repealed from 1 October 2009.