Tax considerations for new water entities

The detailed tax implications will depend on the structure and operating model adopted.  Importantly, the arrangements required during transition may differ from those needed once the organisation is fully operational. 

Identifying these issues early can help avoid compliance problems and ensure tax arrangements work in practice. Below are five areas councils and new water organisations should consider as they prepare for establishment and transition.

While the enabling legislation provides favourable income tax settings for water organisations, including exemptions for certain income, there are still practical tax obligations that can be overlooked during establishment and transition.

Key questions:

• Does the water organisation need to file income tax returns? The default position is that a tax return will be expected by Inland Revenue but provided the water entity only receives exempt income there is no need to file. That said, best practice would be to file a ‘nil return’ initially and notify Inland Revenue that no future income tax returns need to be filed. Failure to address though, could lead to penalty notifications.
• A water organisation qualifies for an Resident withholding tax (RWT) exemption but an exemption certificate needs to be obtained. Failure to do this will result in RWT being unnecessarily deducted from interest income.
• Do any payments made by the entity give rise to Withholding tax (WHT) obligations, and who is responsible where payments continue through council systems during transition? This is particularly relevant for the directors (noting the extensive Inland Revenue guidance on WHT and GST relating to directors and board members) but more broadly the range of  Schedule 4 activities.
• More broadly, are all the appropriate Inland Revenue registrations and processes in place for establishment and transition?

GST can become complex where responsibility for delivery of water services and the assets and liabilities transfer before all of the supporting activities do, or where councils continue to bill, collect, procure or fund activities during transition.

Key questions:

• Who is supplying the water service, who sets the charge and who is responsible for accounting for the GST?
• What amounts are being charged and by whom? Will there be differing treatments between how water service charges, water rates, development contributions, trade waste or other charges are being managed?
• Where a council continues to provide billing and/or administrative support, is it acting merely as an administrator, or as an agent for the water organisation? Are all parties clear of their obligations and what this means?
• Are the appropriate agency agreements in place? Where relevant, have the parties also agreed to agency opt-out arrangements (particularly for development contributions) and buyer-created taxable supply information agreements?
• Is the plan to issue separate invoices for charges, shared invoices, or invoices as agent or administrator? How does this impact the time of supply for GST purposes, noting the specific GST time of supply rule for charges for water services.
• How should development contributions, inter-entity funding, shared service charging, establishment costs and existing grant arrangements be treated and managed?
• Where councils currently use financial contributions, how will these arrangements be managed following the transfer, particularly where multiple councils are involved?
• How will the GST position change when the transition model moves to the intended steady-state model?

The intended GST treatment needs to be reflected in transfer agreements, service agreements, systems and processes, particularly where councils continue to provide support after establishment. Getting these arrangements right is essential to meeting ongoing tax compliance obligations.

The statutory transfer is only part of the picture. Some assets or arrangements may sit outside the transfer mechanism or carry their own tax considerations.

Key questions:

• Do all assets, liabilities and arrangements fall within the intended statutory transfer framework?
• Are there specific issues for land, buildings, leases, licences, easements or other retained rights?
• Could property use, valuation or the way assets are transferred create GST or income tax questions?
• Have items outside the core transfer been identified early enough to deal with separately?

Transferring employees into a new water organisation involves more than a HR or payroll exercise. Existing benefits and workplace arrangements may not transition in the same way as the employment relationship itself.

Key questions:

• Who is the employer from the transfer date, and who will operate payroll and meet PAYE obligations?
• How will the appointment of new employees be managed before the water organisation becomes operational?
• If a council continues to process payroll during transition, how will employee-related costs and responsibilities be allocated?
• How will accrued annual leave and other employee entitlements be transferred?
• Which vehicles, car parking arrangements and other employee benefits will continue after transfer and will the Fringe Benefit Tax (FBT) outcomes be impacted as a result of the transfer to the water organisation?
• Could benefits provided by a council or another party still be connected with employment by the water organisation, creating additional FBT obligations?
• Are the necessary processes in place to meet the water organisation’s first FBT reporting obligations?

Early engagement with Inland Revenue about the transfer of employees can help avoid payroll-related issues. FBT arrangements should also be reviewed ahead of transition, particularly in relation to motor vehicles and the anticipated changes to the applicable rules contained in the September Tax Bill.

A technically sound tax position still needs to work through the legal agreements, billing model, finance systems and day-to-day processes, particularly where multiple councils are involved.

Key questions:

• Can systems distinguish council and water-entity revenue and expenditure, and get information to the right entity on time?
• Can payments, refunds, credit notes, bad debts and partial payments be allocated correctly?  Is there a priority payment allocation and will this impact on the application of penalties?
• Do the legal agreements, accounting treatment and operational processes tell the same story?
• For multi-council water organisations, are participating councils taking a consistent approach to billing, agency arrangements, funding and tax reporting?

Start the tax conversation early

There is no one-size-fits-all approach to tax for water organisations. Different ownership structures, transfer arrangements, charging models and systems will raise different considerations, and the arrangements needed during transition may differ from those required in the longer term. While the establishment transaction itself may be relatively straightforward, much of the complexity lies in the ongoing arrangements for funding, billing, property, shared services and employee benefits. Addressing these issues early can help councils and water organisations establish clear responsibilities and practical, workable tax arrangements.

How PwC can help

PwC New Zealand has more than 20 years’ experience supporting local authorities on tax matters. We've also worked with Taituarā on submissions relating to the tax settings for water organisations and supported councils among the first to establish new water organisations.

We can help councils and water organisations identify and address the tax considerations relevant to their proposed operating models, working alongside legal, finance and operational teams to develop practical solutions.