"Revenue from the community
for the community"
Discussion Document - Income Tax
26/08/2006 10:12:08 a.m.

  REVENUE REFORM DISCUSSION DOCUMENT

“for a better and fairer tax system”

Approved for public release by

 

Chief Commissioner of Revenue

 

If you have any comments please send them to the following address

Send comments to

Post to:
Revenue Reform Information Office
Revenue Services Department
Railway Road
PO Box 5670
Nuku’alofa
 
Otherwise:
By fax: 26 638
By e-mail: rrio@revenue.gov.to
www.revenue.gov.to
www.tonga-now.to
For further information phone: 21 030

Comment deadline

30 October 2006

 

“Thank you for your participation”

 

1.       Purpose

This discussion document seeks your views on the government’s revenue reform programme as well as the changes being proposed to Income Tax, Company Tax and Customs Duty. 

 

2.       Introduction

The revenue reform is an integrated package of changes aimed at improving Tonga’s tax administration and collection system.  We have completed the first two phases which were the Revenue Services Administration Act (RSAA) and introduction of Consumption Tax. We are now embarking on the third phase which comprises of Customs Duty and Income Tax reforms.  We need a tax system that is fairer and better for taxpayers – this is the main rationale behind revenue reform.

 

3.       Background

The revenue reform programme began in 2003 with the introduction of the Revenue Services Administration Act. That Act provided the foundation for a modern system of revenue administration based on self-assessment and voluntary compliance. In November 2004 the Revenue Services Department installed the Revenue Management System (RMS) to automate the processing and collection of tax. This represents a major advance in the capacity and capability of the Revenue Services Department to carry out it functions.

The next step in the revenue reform programme was the introduction of Consumption Tax on 1 April 2005. Consumption Tax (CT) replaced three former taxes - Port and Service Tax, Sales Tax, and Fuel Sales Tax. There will be a settling in period, as experienced by all tax administrations in both developed and undeveloped countries, which is expected to take up to 12 months before the merchant community, the public and Revenue Services are fully familiar with the operation of the new tax.

The final steps of the revenue reform programme are the changes being proposed for Income Tax, Company Tax and Customs Duty. We aim to implement the new changes on 1 July 2007.

 

 

4.       New legislation: Income Tax Act

The RSSA was passed in 2002 and did not come into operation until 1 July 2004.  The Act provides a common set of administration rules for Consumption Tax and Income Tax. However, it does not provide for self assessment.  The major changes brought about by the RSAA were the introduction of uniform penalties for CT, Income Tax and PAYE, changes to the Objections and Appeals process, including the establishment of a new Independent Tax Tribunal, the introduction of a system of taxation rulings, more effective recovery powers and the introduction of a single taxpayer identification number (TIN).

In order to make the changes to our tax system we need new legislation.  This legislation has been developed as the Income Tax Bill which outlines the laws governing the new tax system.  The Bill has been sent out for public consultation and we are waiting for public submissions before tabling the Bill in Parliament late 2006.    

The new Act is written in simple and easy to understand language which will greatly assist taxpayers and their agents.  Income Tax will be based on self-assessment and strong monitoring and compliance by Revenue Services. 

 

 

5.       Context for reform

We conducted extensive research and analysis on our current tax system which identified some major flaws.  These include:

·         High burden of tax on poor.

·         Incidences of tax avoidance.

·         Limited interaction with taxpayers.

·         Inefficient collection processes.

We propose to develop a tax system that is fair, efficient and effective to:

·         Promote economic development by encouraging good business practice.

·         Remove barriers to domestic and foreign trade.

·         Foster efficient enterprises.

·         Collect revenues to pay for essential public services.

The new tax system will be “better and fairer,” it will be much harder than in the past for people to escape paying their fair share.    

Important too, is the recognition that fostering faster growth of the domestic economy requires improved incentives, and better access to skills and resources that the old taxation system inhibits. Since business development is the foundation of economic prosperity, taxation that is business-friendly and free of manifest distortion is an important component underpinning a richer future for the Kingdom.

The Government also considers tackling fraud one of the central objectives for revenue reform, in order to protect:

  • The revenue required for investment in public services.
  • The wider objectives behind the level of taxation on particular goods.
  • Honest businesses from unfair and criminal competition.
  • Owners of intellectual property rights such as brands, trademarks and copyrights from counterfeiting.
  • Society from the scourge of organised crime.

·         Local communities from the debilitating effects of criminal networks.

 

 

6.       Guiding principles

The government has developed a set of principles to underpin the proposed changes to our tax system.  We want to ensure that any changes are fair and do not hurt those that are most vulnerable in society.  The principles that will provide a fair tax system are as follows:  

  • Capacity to pay - Income tax should be based on an individual’s capacity to pay which is measured by their total income regardless of its source whether it is from salary or wages, profits or dividends, trading etc.
  • All income should be taxed - If income is the measure of an individual’s ability to pay tax then all income should be taxed alike.
  • Burden of tax should not be on the poor - People on high incomes should pay more tax because they have more discretionary income and ability to pay.
  • Fair income distribution - People have the opportunity to either spend or save but those on low income have less opportunity to save so we need a process to distribute the burden of tax fairly.
  • True measure of tax burden – People need to understand that the true measure of the tax burden is not what the government raises in taxes but what it spends on providing public services. 
  • Share the tax burden – Bringing more income to the tax net will lower the tax rate which means people pay less tax. High tax rates acts as a discouragement to private investment because it increases the cost of doing business.

·         Not over-tax the formal sector - The business sector represents a small share of total output but a higher proportion of the available tax base. The pressure to raise more tax to fund the cost of providing public services should not constrain private investment and undermine growth and sustainable public revenue.

 

 

7.       Proposed changes to Income Tax on 1 July 2007

Our current income tax system is as follows (based on 2004 figures):

·         You pay 10% for all income above the $2,500 threshold.

·         Income under the $2,500 threshold is tax free.

·         There are approximately 17,800 individual taxpayers in the Kingdom who file tax returns.

·         Individual taxpayers who file returns declared incomes totalling $139 million which represents 34% of GDP.  

·         Total tax revenue collected from individual taxpayers was around $10 million.

·         Approximately 14,400 people claimed that they spent $42.7 million for personal exemptions which the government refunded/exempted at a cost of $3.8 million in revenue foregone.

The government proposes to reform the current income tax system by implementing the following changes on 1 July 2007:

·         Increasing the income taxable threshold from $2,500 to $5,000.

·         Setting the tax rate at 10% for income above the $5,000 threshold up to $20,000.

·         Setting the tax rate at 20% for income above $20,000.

·         Abolishing all personal exemptions for income tax.

Consideration will be given to removing credit for export sales and special deductions for tourism development while introducing specific deductions in the Act for accelerated depreciation and investment allowances targeted at developing the business sector generally.

PAYE will be a final tax which means there will be no need for salary and wage earners to lodge an income tax return unless they are earning other income.  This measure will reduce cost of compliance for taxpayers and divert scarce resources in Revenue Services from transactional work to more productive work such as taxpayer service - advice, education; recovery and compliance work.

 

 

8.       Personal exemptions

Currently, individual taxpayers are entitled to claim tax exemptions for school and tuition fees, charitable donations as well as private dwellings.  There is no limit on the amount of personal exemptions you can make as long as it falls within the above definition.

In 2004, claims for personal exemptions were made by 14,400 people that represented 81 percent of individual taxpayers who files a return. The average claim was for a deduction of $2,962.  The total value of claims for personal exemptions was $42.7 million which cost the government $3.8 million in revenue foregone.  

Exemptions were allowed to provide assistance to those with large families and to cover donations.  However, it seems that those claiming exemptions have very high incomes.  The average income of people claiming exemptions was higher than the overall average income ($8,747 versus $7,836).

The analysis of personal exemptions found that a large majority of exemptions were claimed for school and tuition fees. 

Personal exemptions reduce taxable income by 30% to $97 million of which 38% is sheltered from tax by the $2,500 threshold.

 

9.       Income undeclared

Our analysis of the tax returns found that some incomes were not declared such as interest and dividends or rental income when in fact we know from the census that around 900 residents stated that they received rental income while only 200 declared this income in their tax returns.

Farmers are wholly exempt from paying income tax so their earnings are not subject to tax.  This needs to be debated further by the public because farming income is worth an estimated $85 million.  We need to ask the question: is it time to bring farming into the tax net especially with the higher demand on the public purse and rising cost of public services?  Should they help in a more direct way like all other industries? 

 

10.    Impact of revenue reform

We have undertaken extensive research and analysis to determine the financial impact of the revenue reform programme on Tongan society.  The results found that the impact is effectively nil and that small pockets are more affected than others. The results have shown that the tax burden on households in Nuku’alofa will increase more than the other islands in Tonga, while ‘Eua, Ha’apai, and smaller islands will have a lesser tax burden.  The households in the higher income decile are estimated to pay more tax than those with lower incomes. 

 

11.    Proposed changes to Company Tax on 1 July 2007

The current Company Tax rates are as follows:

Resident company

Non-resident company

Income  bracket

Marginal tax rate

Income bracket

Marginal tax rate

$

%

$

%

0-100,000

15

0-50,000

37.5

100,000 +

30

50,000 +

42.5

 

However, we have identified some flaws in the current system because of the following problems:

·         Some businesses ‘pay’ large management fees which should be subject to tax.

·         The incidence of tax avoidance is rising.

·         Some businesses are under-reporting their total incomes deliberately.

·         The financial records of some businesses are very poor which creates problems when determining the correct company tax.

Therefore, we are considering some of the following ideas for further discussion with the business community and the general public before a final decision is made:

·                The proposed rate of company tax will be 25% for resident and non-resident companies instead of 20% previously proposed.

·                The proposed minimum tax for large businesses (CT-registered) will be based on 1% of turnover recorded for Consumption Tax.  Provisional tax payable will be 1% of quarterly turnover.

·                The proposed presumptive tax for small businesses (not CT-registered) will be 3% of turnover.

·                Tax on certain payments to non-residents

o        Insurance premiums (gross amount of premium) – 5%

o        Interest, royalty, dividend or technical services (gross amount of payment) – 15%

·                Abolishing Industry Development License exemptions.

·                The availability of depreciation allowances accelerated rates with the choice of straight-line or diminishing-daily bases – see appendix 1

 

12.    Proposed changes to Customs Duty

This year we are proposing to introduce a Customs Tariff Schedule that complies with Tonga’s obligations as a WTO member nation. Preliminary to the adoption of this Customs Tariff Schedule will be improvements in taxation administration, including the full deployment of PC-Trade as the computerized system for managing and monitoring imports and duty.

The terms of Tonga’s accession to the WTO place restriction on the level of duty that may be imposed on imports, and requirements not to discriminate against imported goods from other member nations. The so called ‘final bound rates’ restrict to 15 or 20 percent the rates that may be applied to imports. Since Tonga currently levies import duties at up to 45 percent on general goods, and rates of around 30 percent on excise goods, there is a significant revenue effect from adoption of the WTO Customs Tariff Schedule that must be made up by other indirect taxes.

Customs Tariff Schedules rates that are consistent with WTO accession will apply with effect from 1st of August 2006.

The maximum rate applied to imports will be 20 per cent, with any non-excise goods that are currently dutied at higher levels having a 20 per cent rate instead.  The import tariff rates applying to excise goods will be set to a rate of ‘Free’[1] and dealt with instead by a new Excise Tax applying to alcohol beverages, tobacco and petroleum fuels.

The process of globalisation of world trade and the formation of regional trading blocs means that countries that wish to participate on an equal footing in trade with their near neighbours must align their systems of internal taxation and border taxes.

 

13.    Proposed changes to excise duty

We aim to move towards attaining uniform applied rates by product category, as follows:

  • On the introduction of Excise Tax, petroleum fuels will become subject to specific rates at the equivalent of the then-prevailing ad valorem rates.
  • Revision of the excise duty rates applied to tobacco products to achieve a uniform treatment according to tobacco content.
  • Excise duty applied to alcohol beverages will change to provide uniform taxation of products on an alcohol strength basis. This will replace the current system of which is a mixture of both input and alcohol strength taxation.

These measures bring closer the achievement of the goal of uniform taxation of these goods and on a basis consistent with alcohol or tobacco content, or product volumes.

The government has yet to make decisions on how to recover the revenue lost from reducing Customs Duty on vehicle imports from 45 percent to 20 percent as required by the terms of WTO accession. The options include a graduated excise tax based on engine capacity or an increase in the registration fee paid by motorists. In considering the available options the Government will have regard to the recommendations it has recently received on provision of roading infrastructure.

14.    Business competitiveness

Application of Customs Duty to goods that by their nature are likely to be wrought into other goods or consumed in a manufacturing process, distorts the pattern of commerce and trade. These goods include capital goods used in investment and intermediate inputs that are purchased by business. Taxation of these business inputs results in an increase in production costs in Tonga compared with other countries that do not relieve their manufacturers and processors of this tax burden.

Such input taxes may cascade, producing highly variable effective tax rates between industries and even within a single industry. Input taxes reduce the effective rate of protection provided by a nominal final-good tariff and may remain unrelieved in the cost of export goods (unless this tax burden is otherwise removed) hampering competitiveness in overseas markets.

It is desirable to relieve resident processors and manufacturers of such costs wherever possible as a competitiveness and trade-enhancing measure – especially when some processors and manufacturers will face greater competition from imports after adoption of the WTO Tariff Schedule.

The cost to revenue of eliminating duty from capital goods and non-fuel intermediate inputs is $4.8 million in a full year. The following decisions are included in the 2006/07 Budget:

  • Capital goods will be free of tax on importation
  • Selected important inputs to the Brewing industry are to be free of import duties
  • Customs Duty on non-fuel intermediate inputs will be progressively abolished over three years commencing 1 July 2007.

 

 

15.    Commitment to taxation reform

Tonga has come later to the taxation reform game by comparison with its near Pacific island neighbours. This provides the opportunity to learn from their experiences and pick the best of their practices for adaptation to the Tongan setting.

The political commitment to taxation reform from within the Government of Tonga has found expression in a programme of legislative reform that is well advanced and aimed at modernising the system of taxes, including the powers available for administration of taxes in line with best practice.

 

16.    Consultation

The Government is determined to consult widely with all key stakeholders regarding the proposed changes outlined in this document.  These are only initial ideas to provide a basis for discussion.  We intend to consult with all stakeholders which includes the general public, villages, business community, public servants, special interest groups as well as the outer Island communities.  We will use public fono, village meetings, reference groups as well as one-on-one meetings as part of our consultation.  We want to provide full information to the public and to give them the opportunity to provide feedback before any decision is made. 

This document is designed to create debate and discussion and is part of the consultation process that is an integral part of all future government policies.    

 

17.    Where to next

Please read this document thoroughly and send us your comments.  No decision has been made except for laying out the proposed ideas in this document.  This is your opportunity to have your say on what you would consider to be a fairer and better tax system for all citizens.

Depreciation Schedule

The proposed schedule of depreciation rates is as follows:

Asset

Depreciation Rate

 

Diminishing value

Straight-line

Motor vehicles; buses and minibuses with a seating capacity of less than 30 passengers; goods vehicles with a load capacity of less than 7 tonnes; computers and data handling equipment; and construction equipment and earthmoving equipment

 

 

40%

 

 

25%

Buses with a seating capacity of 30 or more passengers; goods vehicles designed to carry or pull loads of more than 7 or more tonnes; specialised trucks; tractors; trailers and trailer-mounted containers; and plant and machinery used in manufacturing, mining, or farming operations

 

 

30%

 

 

20%

Vessels, barges, tugs, and similar water transportation equipment; aircraft; specialised public utility plant, equipment, and machinery; office furniture, fixtures, and equipment; and any  depreciable asset not included in another category

 

 

20%

 

 

12.5%

Buildings

-

5%

Thank you for your participation



[1] ‘Free’ is a ‘zero’ rate, which while practically the same as an exemption, has the effect of indicating the goods are dutiable but at the zero rate, which is below the ceiling rate.

Improving the lives of Tongans through effective & efficient tax & customs administration