Papua New Guinea Taxation Review (2013-2015)taxreview.gov.pg/wp-content/uploads/2015/08/15.08... · Papua New Guinea Taxation Review (2013-2015) Issues Paper No.8: Personal & Retirement

Papua New Guinea Taxation Review

(2013-2015)

Issues Paper No.8:

Personal & Retirement Income Taxation

Prepared by

The Taxation Review Committee

July 2015

iii

Title of Publication

[This page intentionally left blank]

Page i

Consultation Process

The Tax Review Committee (Committee) is seeking your feedback and

comments on this Issues Paper. This is the eighth of Issues Paper released by

the Committee throughout 2014 and the first half of 2015. Issues Papers are

designed to promote targeted exchange and robust debate on particular areas

of discussion on PNG’s taxation system. Consultation questions have been

included throughout the Issues Papers including this one to help guide

responses but stakeholders should feel free to raise any issue of relevance.

Feedback regarding this Issues Paper will help to inform the development of

the Review Committee’s draft recommendation to the Government, and which

will be subject to a further round of consultation before finalization.

To ensure there is transparency in the consultation process, all submissions are

necessarily published on the Tax Review website (www.taxreview.gov.pg)

unless the submission is by justification, marked ‘CONFIDENTIAL’.

Due date for submissions in response to this particular Issues Paper is 28

August 2015.

All submissions should be sent via mail and/or email to:

Head of Secretariat

Tax Review Secretariat

c/- Department of Treasury

P O Box 542, Waigani, NCD

Email: [email protected]

For any other general enquiries, email: [email protected] or call the Tax

Review Secretariat on (675) 325 3775 or (675) 325 5977.

mailto:[email protected]

mailto:[email protected]

Page 2

TABLE OF CONTENTS

Consultation Process ................................................................................... i

TABLE OF CONTENTS ........................................................................... II

FOREWORD ......................................................................................... III

EXECUTIVE SUMMARY ......................................................................... V

Consultation Questions ............................................................................. vi

CHAPTER 1: OVERVIEW OF THE PERSONAL INCOME TAX

SYSTEM 10

CHAPTER 2: TAXPAYERS IN THE PERSONAL INCOME AND

RETIREMENT TAX SYSTEM .................................................................. 15

CHAPTER 3: FEEDBACK FROM CONSULTATION ................................. 18

CHAPTER 4: OPTIONS FOR REFORM OF THE TAX FREE

THRESHOLD AND PERSONAL INCOME TAX RATES ............................... 26

TABLE 3: REGIONAL COMPARISON OF TAX FREE THRESHOLDS ................ 27

CHAPTER 5: OPTIONS FOR REFORM OF THE TAX ON

TERMINATION PAYMENTS .................................................................. 35

CHAPTER 6: REFORM OF REBATES AND CREDITS ................................ 40

CHAPTER 7: TAXATION OF FRINGE BENEFITS .................................... 48

Exemptions .............................................................................................. 51

CHAPTER 8: TAXATION OF INVESTMENT INCOME .............................. 53

CHAPTER 9: TAXATION OF RETIREMENT BENEFITS ............................ 55

CHAPTER 10: OTHER ISSUES ............................................................. 69

ABBREVIATIONS ................................................................................ 73

REFERENCES ...................................................................................... 74

ATTACHMENT: THE TAXATION OF PERSONAL INCOME AND

EMPLOYEE BENEFITS .......................................................................... 76

Page iii


FOREWORD

In 2013, the O’Neill-Dion Government committed to comprehensively review

Papua New Guinea’s revenue regime with the main aim of ensuring that it

remains relevant, efficient and effective.

Government revenue is critical to funding essential services and infrastructure

for Papua New Guinea (PNG), to share the benefits of prosperity across

families, communities and regions and to lay the foundations for future

growth. Consequently, this Review is a high priority of the Government and

an important platform of its economic and fiscal strategy.

The last comprehensive taxation review was undertaken in 2000. PNG has

undergone substantial economic, fiscal and technological developments over

the past 14 years, so it is timely that another review is done to ensure the

country’s tax system is modern, robust, is in line and congruent with

economic, social, technological and political changes, and is able to support the

country’s medium and long-term economic and social development objectives.

While formally titled a ‘Tax Review’, the Review will, in fact, consider other

sources of revenue, including non-taxation revenues.

This paper, the eighth in a series of issues papers to be released by the Tax

Review Committee, focuses on personal and retirement income taxation.

Personal and retirement income taxes are an important source of revenue for

PNG and are likely to continue to be so in the years to come unless there is a

shift of the tax burden from narrowly based personal income and retirement

taxes towards a more broadly based taxes including GST.

Over many years the Government has relied on personal and retirement

income taxes to provide a significant contribution to the Government’s

revenue needs. The Tax Review Committee notes that there has been

significant levels of concern in the community regarding the tax burden borne

by the small portion of people paying personal and retirement income taxes

and believes it is time to shift the tax burden. Consequently, as part of this

paper, the Committee has included a number of possible areas of personal and

retirement income tax reform for the Government to consider. As such, and

consistent with the Committee’s commitment to an open Review process, the

Page 4

Committee is also using this paper as a means to obtain feedback on specific

options for reform.

As with others this Issues Paper considers a range of issues and potential areas

of reform related to the country’s personal and retirement regime. In doing so

it draws on a number of suggestions that have been put forward as part of the

‘Blue Sky’ consultation process. This paper provides an opportunity to further

explore these and other issues, and to seek further reactions and responses

from stakeholders on the potential direction for reform in this important area

of taxation.

The Committee thanks those who to date have commented on areas of

potential reform, and looks forward to receiving submissions and comments

on this particular paper. As well, the Committee looks forward to any future

engagement with interested stakeholders on the future of Papua New Guinea’s

tax system.

Sir Nagora Bogan, KBE

Chairman, Tax Review Committee

Page 5

EXECUTIVE SUMMARY

This paper includes a broad discussion on the desirability of reforming PNG’s

personal income tax (PIT) system. It also discusses the taxation of retirement

incomes.

The current progressive PIT scale is the main device to provide fairness across

the tax system. Those who earn higher income bear a greater tax burden than

those who are on low incomes. However, PNG has a large and significant

informal sector when compared to the formal sector. As a result, tax scales are

not as effective in providing equitable tax outcomes. Further, high tax rates can

also impact on incentives to work or for workers to remain in the formal sector.

The choice of tax rates and their application to taxpayers are matters of

judgment. Societies have to balance questions of fairness and income

distribution, against the revenue required to meet society’s needs. However, in

balancing these matters it is also important that the tax system is pragmatic,

and takes account of what is fiscally administrable given the economic

circumstances.

The Committee has considered these matters and arrived at the conclusion that

PNG needs to lower its personal tax rates for all income earners but more

particularly for lower income earners. At the same time, the tax system be

made more simple by removing a number of the concessions and rebates

currently available. The Committee believes lowering tax rates will help

increase the incentive to work and ensure that PNG’s salary and wage earners

are not bearing the very high revenue burden. It should be noted however,

that lowering personal income tax rates also means increasing taxes in other

areas.

In Issues Paper No.3: The Case for Tax Reform and Broad Reform Directions which

was released in October 2014, the Committee raised the possibility of

reforming the PIT along the lines mentioned above. The Committee received

strong feedback to that Issues Paper with the overwhelming view of

submissions being that current level of tax imposed by PIT is too high.

Reforming the personal income tax scales can either be revenue neutral with

adjustments in the tax free threshold funded by changes to the tax rates, or in

the case of major change, funded from other tax reforms. The Committee

Executive Summary

Page 6

recognises that it is a matter for the Government to decide the extent to which

the PIT is reformed, by how much and by when. To assist in the discussions,

the Committee has suggested a number of possible changes and these matters

were raised in Issues Paper No.3 and which are further considered in this paper.

Consultation Questions

Below are the consultation questions posed in this Paper. As noted above, they

are intended to act as prompts only and stakeholders should feel free to raise

any other related views/issues.

Options for Reform of the tax free threshold and personal income tax

rates.

Question 4.1 – Do you agree that adjustment to the tax free threshold is the

best mechanism to give tax relief? Do you have any views on whether

adjustments to individual marginal tax rates could provide a similar level of

relief? And if so, what changes could be made?

Question 4.2 – What is your response to the Committee’s observation that the

tax free threshold could be raised to at least K15,000 as part of a package of

possible reforms that include reductions in concessions and removal of rebates

and an increase in the GST?

Question 4.3 – What are your views on maintaining the progressivity of the

existing marginal tax rates but with adjustments reflecting changes to the tax

free threshold and the number of tax bands?

Question 4.4 – What are your views on the Committee’s proposal that current

top marginal tax rate be retained for the time being?

Question 4.5 – Do you agree with the proposal that future reductions in the

top marginal tax rate be considered in conjunction with reductions to the

corporate tax rate?

Question 4.6 – Do you have a view on whether the number of tax bands

should be reduced in number? If so what tax bands are appropriate for PNG?

Question 4.7 – Do you have views on what the marginal tax bands should be

and at what income levels should they apply?

Executive Summary

Page vii


Question 4.8 – To what extent are non-resident salaries likely to be grossed

up?

Question 4.9 – Do you agree with the Committee’s recommendation that

resident and non-resident tax rates and thresholds be harmonised?

Options for Reform of the Tax on Termination Payments

Question 5.1 – Should the taxation of redundancy payments in cases of

medically caused retirements be taxed more lightly? What do you think the

policy rationale should be for reducing tax on redundancy payments in this

situation?

Question 5.2 – Should Section 46CA be amended to remove the 30 person

redundancy requirement as discussed? If so what integrity measures should be

applied to ensure only genuine redundancy is covered?

Question 5.3 – If concessions are to remain should Section 46CA be replaced

by a simple Kina cap on the amount of termination payments subject to the

concession?

Question 5.4 – Should the taxation of termination payments be determined

according to the length of service an employee has with his/her employer?

Should the age of an employee be another consideration in the provision of tax

concessions?

Question 5.5 – Should long service leave be included in any new arrangements

or should it continue to be taxed under the existing tax rules?

Reform of Rebates and Credits

Question 6.1 – For the purpose of simplifying the system for PIT and business,

should the dependants rebate be abolished and folded into the standard tax

rates?

Question 6.2 – What are your views on removing school fee rebate and rolling

the savings into lower tax rates?

Question 6.3 – Do you support the removal of the salary and wage expenses

rebate and rolling the savings into lower tax rates?

Executive Summary

Page 8

Question 6.4 – Do you agree with the Committee’s reasoning that the election

expenses rebate be retained?

Question 6.5 – Do you support the removal of the rebate on non-salary and

wage loss?

Question 6.6 – Do you support the current arrangements in the Income Tax

Act for the relief of double tax?

The Taxation of Fringe Benefits

Question 7.1 – The Committee welcomes stakeholder comments on the

taxation of non-cash benefits including suggestions for changes to the existing

taxation of benefits that would improve the overall fairness and administration

of PNG’s personal income tax system.

Question 7.2 – Do you agree that the taxable value of the housing allowance

should be adjusted to take account of changes in house values and rentals in

PNG?

Taxation of Investment Income

Question 8.1 – Do you have any comments on the taxation of investment income?

Taxation of Retirement Benefits

Question 9.1 – Do you have any comments on the taxation of contributions to Superannuation Funds?

Question 9.2 – What transitional rules do you think would be required if the mandatory employee contributions of 6 per cent were made tax free?

Question 9.3 – What are the consequences on superfunds of current earnings tax?

Question 9.4 – Do you have any examples of the taxation of retirement benefit withdrawals where there are inequitable outcomes for retirees?

Question 9.5 – How can RSAs be made more attractive for retirees as a way to manage their income during their retirement?

Executive Summary

Page ix


Question 9.6 – What tax changes could be introduced to encourage the take up of pensions in PNG? What features or aspects should pension accounts have and which are not already available in RSAs? How could or should market risks be managed?

Other Issues

Question 10.1 – Should the definition of residence for tax purposes be revised?

Are there any issues associated with using the 183 day rule discussed above?

Question 10.2 – Withholding tax regimes need careful analysis, taking into

account PNG circumstances. In particular, are the incentives for tenants to

comply with these rules greater than those of landlords to comply with the

existing rules including potential TIN matching?

Question 10.3 – What would be the issues associated with the developing a

rate that would collect a suitable amount of tax while limiting the need for the

extensive issue of refunds?

Question 10.4 – Are there any issues on the taxation of income or benefits that

this chapter has not covered? If yes, what are they?

* * * * *

Page 10

CHAPTER 1: OVERVIEW OF THE PERSONAL

INCOME TAX SYSTEM

Personal income tax (PIT) is an important source of tax revenue for PNG, and

accounts for about one third of the country’s total revenue collections in 20141.

PIT collections represent around 8 percent of nominal 2014 GDP, which is

higher than most other countries in the region.2

PIT and company income tax are the two (2) main income taxes. PIT applies to

personal income, which covers employment income and business income from

partnerships and sole traders. Employment income includes non-cash ‚fringe‛

benefits. Investment income (for example: interest, dividends, royalties and

property rental) derived by individuals is also personal income. Further

information about operation of the personal income tax system can be found at

the Attachment of this Issues Paper.

There are main two (2) types of assessment for individuals (i) a fortnightly

salary or wages tax assessment; and (ii) an annual non-salary or wages income

assessment. Salary and wage earners are generally not required to submit

annual tax returns. The tax period is a fortnight and tax is assessed based on

the reference to the salary or wage income earned in that fortnight unless they

earn other income in excess of K100. However, if an employee incurred

expenses in earning salary or wage income, and the expenses exceed K200 in

any fiscal year, the employee may lodge an income tax return to claim a tax

rebate calculated at 25 per cent of the extent to which the expenses claimed

exceed K200.

1 Based on PNG Treasury Final Budget Outcome 2014. Nominal GDP estimated as 40,800 kina

(millions). 2 The Committee‟s analysis based on IMF Article IV data and Finance Ministry data.

http://www.businessdictionary.com/definition/personal-income.html

Page 11


Different PIT rates that apply to residents and non-residents:

Table 1 Individual Tax Rates

Residents Non-Residents

Taxable Income (K)

Tax Rate on excess

Taxable Income (K)

Tax Rate on excess

Nil Nil Nil Nil 22

10,000 Nil 22 10,000 Nil 22

18,000 1,760 30 18,000 30

33,000 6,260 35 33,000 35

70,000 19210 40 70,000 40

250,000 91,210 42 250,000 42

Withholding taxes applied to investment and certain income:

A dividend withholding tax (DWT) of 17 per cent tax is applied on all

dividends derived from sources within PNG and a 10 per cent rate on

dividends received from mining companies. No dividend withholding

tax applies to dividends received from petroleum and gas companies.

A lower rate may apply to non-residents under tax treaties. The tax is

deducted on dividends received by non–residents, resident individuals

and resident trust estates and is a final tax.

Interest withholding tax: Most interest derived by residents is subject

to withholding tax at a rate of 15 per cent. A lower rate may apply to

non-residents under tax treaties. This tax is an interim tax, except in the

case of non-resident recipients.

Royalty withholding tax: Royalties paid to non-residents for provision

of technical know-how, trademarks, secret formulas, patent, design or

model, copyright etc, are subject to a final tax at a rate of 10 per cent.

However where royalty income refers to income derived by

landowners from the exploitation of their resources in mining,

petroleum, gas and forestry, the rate is 5 per cent. This tax is a final tax .

Management fees withholding tax: Management fees paid to non-

residents for management services performed outside PNG are taxed at

a rate of 17 per cent of the gross management fees paid. This rate is

reduced under tax treaties.

Page 12

Foreign contractors’ withholding tax: A foreign contractor in the

construction sector or for providing professional services is liable to a

tax of 25 per cent of the gross contract value at the non-resident tax rate

of 48 per cent. The effective tax rate is 12 per cent.

Does the PIT meet principles for good taxation?

The choice of tax rates and their application to taxpayers are matters of

judgement. Societies have to balance questions of fairness and income

distribution, against the revenue required to meet society’s needs. However, in

balancing these matters it is important that the tax system also be pragmatic,

taking account of what is fiscally administrable given the economic

circumstances. Against some measures, the current PIT arrangements have

been very effective in raising revenue. However, the current PIT system needs

to be evaluated more generally against recognised tax design principles.

Revenue mobilisation: PIT is a significant contributor to PNG tax collections.

Yet with government employment being a major proportion of the workforce

subject to PIT, from a budgetary perspective, government employee taxation is

only transfer which does not add to budget capacity.

Chart 1 tax revenue trends in millions of Kina 2009-2013

Competitiveness and Efficiency: PIT is generally regarded as less efficient

than consumption taxation and recurrent taxation of land, but more efficient

Page 13


than company taxation.3 In particular, the relatively high rates of personal

taxation in PNG this can act as a disincentive for people to enter the workforce,

to develop skills or do extra work. In considering the incentives effects of the

PIT system, it is important to keep in mind similar effects of other employment

taxes including compulsory superannuation contributions.

Because small enterprises can trade as sole traders or partnerships subject to

the PIT or take their income as company profits subject to the CIT the

relationships between PIT and CIT rates influence the legal form of businesses

depending on the income level and tax rates of enterprises. This issue is

inherent in the design of the ’progressive’ PIT and ’flat’ CIT scales, but it

weakens horizontal equity, but also detracts from economic efficiency where

inappropriate forms of business are used (further explanations below).

Fairness: Underpinning the design of the income tax system is the desire to

provide a balance between ensuring that those people with more capacity to

pay, contribute relatively more (vertical equity) and that those with a similar

capacity to pay bear the same burden (horizontal equity).

In many tax systems the PIT plays an important role in providing overall

fairness. The PIT tax scale is progressive, meaning the more income you earn,

you pay proportionately more of your income in tax. This adds to fairness

(vertical equity) because people who earn more pay proportionately more

because they have the capacity to pay and still have more disposal income.

However, PNG’s large informal economy4 means progressive PIT rates can

have only a limited role in redistributing the tax burden. Furthermore, those in

the informal economy escape PIT while salaried employees on similar incomes

have to pay tax, undermining the fairness (horizontal equity) of the PIT. It is

generally understood in developing economies that the most effective way to

reduce inequality is not through taxation but through spending programs and

priorities which target the poor.5

3 See Issues Paper No. 3 : The Case for Tax Reform and Broad Directions . 4 In this paper informal economy means that part of economic activity that is disengaged from

government regulation. Because of this it is hard to tax. 5 Bird, R and Zolt, E 2005, „Redistribution via taxation: the limited role of the personal income

tax in developing countries‟ http://www.researchgate.net/publication/4905326_Redistribution_via_Taxation_The_Limited_Role_of_the_Personal_Income_Tax_in_Developing_Countries

http://www.researchgate.net/publication/4905326_Redistribution_via_Taxation_The_Limited_Role_of_the_Personal_Income_Tax_in_Developing_Countries


Page 14

Equity is also important for taxation of non-cash benefits. If these benefits are

undervalued for tax purposes, horizontal equity may be compromised. For

example; a person receiving cash salary only may pay more tax than a person

who has converted part of that salary to a non-cash benefit.

For non-resident individuals, fairness/progressivity is generally dealt with by

their home country. Non-residents are only taxed on PNG sourced income.

Their home country will tax worldwide income (including PNG income) and

provide a tax credit or exemption for PNG tax. PNG’s lower tax free threshold

for non-residents can be justified on the grounds that when income from non-

PNG sources is taken into account, higher overall levels of tax are appropriate.

On the other hand the different rate scales complicate PIT arrangements and

add to compliance costs.

Simplicity: A good tax system should be simple enough for taxpayers to

understand and meet their tax obligations. It should also minimise the

administrative costs for government and for the taxpayer. Tax free thresholds

and only a few tax brackets and minimising concessional allowances and

rebates simplify the application of the PIT for taxpayers, employers and

administrators.

Trust in and accountability of government: Bringing more people from the

informal sector into the (formal) PIT system can encourage improved

government accountability as more voters have a greater interest in the how

the Government spends their tax Kina.

The Committee, in reviewing the operation of the PIT from a principles

perspective, believes that the tax system can be made more efficient and

effective. As discussed in Issues Paper No.3, the Committee believes that it is

appropriate to reconsider the balance between direct and indirect taxes.

Page 15


CHAPTER 2: TAXPAYERS IN THE PERSONAL

INCOME AND RETIREMENT TAX SYSTEM

PNG has a dual economy comprising a formal, government and corporate-

based sector and a large informal sector where subsistence farming accounts

for the bulk of economic activity in the country. Over 85 per cent of the

population is involved in subsistence farming6. In terms of employment, the

formal sector provides an important employment base, consisting of workers

engaged in mineral production, a relatively small manufacturing sector, public

sector employees and service industries including finance, construction,

transportation and utilities. According to the 2009 – 2010 PNG Household

Income and Expenditure Survey, the formal sector accounts for nearly 60 per

cent of employment.7 As a result formal sector employment contributes much

of the personal income taxation paid in PNG.

As shown in Issues Paper No. 3, one of the significant challenges in

considering tax reform and its revenue consequences is the absence of

comprehensive data in PNG on employment, both generally and in relation to

the personal income tax system. However, a number of agencies do collect

information that provides some guide as the make-up of personal income

taxpayers. As well, information is available about the number of

superannuation accounts – this provides a useful indicator on the number of

superannuation contributors. These information sources are described in the

following sections of this chapter.

Internal Revenue Commission (IRC) Data

The data collected by the IRC is limited and does not include data on each

individual personal income taxpayer. The IRC only receives aggregate

information from employers regarding the salary and wages withheld by the

organisation. This provides a challenge in obtaining an accurate picture of the

breakdown of personal income taxpayers in each tax-bracket. To address this

issue, the IRC conducts occasional surveys of ‘group tax employers’ –

6 See source: http://www.ipa.gov.pg/ 7 National Statistics Office 2009 – 2010 Papua New Guinea Household Income and Expenditure

Survey.

Page 16

employers who collect PIT group tax on behalf of their employees. The

surveys collect data on the number of employees, their total income and total

tax paid, disaggregated into various income bands.

In 2014 the IRC surveyed private sector businesses and government

departments that collected K1344 million in PIT revenue on behalf 168,922

employees (see Table 2). Total PIT revenue in 2014 was approximately K3.2

billion, implying that the IRC survey included employees who contributed

around 42 per cent of all PIT revenue. According to the survey, 28 per cent of

workers earned less than the resident tax-free threshold of K10,000 per year.

Almost two-thirds of employees earned less than K25,000 and approximately

15 per cent earned above K70,000.

Table 2: distribution of PIT taxpayers, 2014

Income Bracket Employees

Gross

Wages

Tax

Deducted

Tax per

person

Average

tax rate

(k)

Kms Kms K/year

0-7000 37797 142.02 5.33A 141 4%

7001-8000 3421 25.60 0.96 281 4%

8001-9000 3356 28.44 1.05 311 4%

9001-10000 2660 25.23 1.01 379 4%

10001-14000 13434 168.21 9.89 736 6%

14001-18000 12188 194.80 17.97 1,474 9%

18001-25000 36846 804.72 98.56 2,675 12%

25001-33000 22871 650.45 102.07 4,463 16%

33001-40000 10146 366.96 69.86 6,885 19%

40001-70000 14077 721.72 171.47 12,181 24%

70001-80000 1647 123.16 34.60 21,010 28%

80001-150000 4848 514.77 161.33 33,278 31%

150001-250000 1539 289.60 96.75 62,864 33%

250000+ 4092 1634.32 573.28 140,097 35%

Total 168922 5690.00 1344.11 7,957 24%

Source: IRC Group Tax Employer Survey 2014 and PNG Tax Review calculations. The average

tax rate is equal to total tax paid divided by gross income rounded up to the nearest whole

number. A Non-residents and part year workers on incomes below K10,000 may pay PIT.

Page 17


Chart 2 illustrates the spread of taxpayers between income bands. The income

bands were chosen to provide some comparison to earlier IRC surveys.

Chart 2 distribution of taxpayers

In a 2008 survey, the IRC reviewed 1,780 businesses that collected K297 million

in revenue on behalf 114,021 workers. Total PIT revenue in 2008 was a little

over K1.1 billion, implying that the IRC survey covered about 27 per cent of all

PIT revenue. According to the survey, 28 per cent of workers were below the

2008 tax-free threshold of K7,000 per year. Almost two-thirds earned less than

K14,000 and only slightly more than ten per cent earned above K25,000.

The survey data in 2014 and 2008 suggest that the distribution of total PIT

revenue collection was heavily skewed towards a small group of high-income

earners. In 2014 those earning more than K150,000 contributed nearly half of

total PIT revenue, whereas in 2008 the contribution was one-third. In 2008 less

than 1 per cent of taxpayers earned more than K150,000, while in 2014 this

figure had grown to over 3 per cent. However, some caution is needed when

considering the significance of this data as it is not comprehensive and the

distribution may not be representative of the total PIT.

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

Percentage of taxpayers

Top of income range (K thousands)

2014 Survey

Page 18

CHAPTER 3: FEEDBACK FROM CONSULTATION

The Committee has received submissions from interested parties commenting

on the Review’s earlier Issues Papers. These submissions raise a number of

matters, some relating to the tax system itself, while others commented on

general issues regarding tax policy. Copies of submissions are available from

www.taxreview.gov.pg.

The following sections cover the main issues raised in submissions regarding

personal and retirement income taxation.

Concessional Tax Treatment for some Groups of Employees

The Committee received several submissions arguing that special

circumstances justified concessional allowances or tax exemption for certain

groups of workers and salary earners.8 Examples given involved those in bible

translation and teachers in remote areas or disadvantaged areas of the country.

The suggestions would either require carve outs from income taxation or

concessional treatment of allowances or even exclusion of some components of

income used for approved purposes.

While acknowledging these arguments, the Committee believes that rather

than adding to complexity of the tax system through additional exemptions or

concessions, it would be better to work towards reducing the tax burden of all

income taxpayers.

Tax Free Threshold

Most of the submissions and comments received have expressed support for

raising the tax free threshold with several submissions arguing for a significant

change to the threshold to ease the burden on taxpayers. The arguments put

forward to the Committee state that the current threshold has failed to keep

pace with inflation and acts as a disincentive to work, especially for part-time

8 See Summer Schools of Linguistics 14 June 2013, New Tribes Mission 16 April 2014, PNG

Teachers „Association 14 MAY 2014.

http://www.taxreview.gov.pg/

Page 19


workers. 9 10 Those submissions proposed thresholds ranging from K18,000, to

K30,000.

Several submissions agreed to the Committee’s rationale that reductions in

personal income tax should be met by broadening the tax base while another

supported the idea of increasing the tax free threshold arguing that salary and

wage earners were already paying additional tax through the GST.

In reducing the level of personal income tax faced by employees, adjusting the

tax free threshold is not the only option. Adjusting the individual tax rates can

also reduce the tax paid by wage and salary earners depending on what

changes are made. One submission picked up on this issue and recommended

that instead of increasing the tax free threshold, changes could be made to tax

rates as a means to reduce the burden on taxpayers.11

The Committee notes the strong support in the submissions on increasing the

tax free threshold. Chapter 4 considers this issue in further detail.

Marginal Tax Rates

The Committee received many submissions on the subject of marginal tax rates

– 22%, 30%, 35%, 40%, 42%. All submissions received by the Committee

supported reforms which reduce tax rates on personal wage and salary

income. A number of submissions noted that the current tax rates made it

difficult for employees to save to help meet other living expenses. Other

submissions noted that increasing tax home pay would encourage savings,

including contributing to superannuation. The observation that high tax rates

also raised the cost of employment for companies was also mentioned.12

However, there were a range of views about the changes that might be made to

marginal tax rates. While most submissions commented on the issue generally,

a few made specific suggestions including reducing the top marginal tax rate

from 42 per cent to as low as 20 per cent. There was a suggestion of aligning

the top marginal tax rate to the company tax rate (30 per cent).13 Another

9 See submissions from Chris Smith dated 31 March 2014 and Deloitte Touche Tohmatsu, 23

May 2014. 10 Consultative Implementation and Monitoring Council (CIMC) 23 May 2014. 11 Adam Smith International, 24 April 2014. 12 Lae Chamber of Commerce, 21 May 2014. 13 Rosa Banik, BPNG, 24 April 2014.

Page 20

submission suggested reviewing and reducing the rates based on analysis of

comparable countries in the Asia-Pacific region.14

Some submissions suggested that any fall in tax receipts from a reduction in

tax rates would be addressed by either increasing the GST or through

increased tax receipts from gambling, dividend and interest withholding taxes

associated with increased disposable income.

These submissions highlight the challenge of balancing the multiple objectives

of the income tax system. The system needs to raise sufficient tax to contribute

to the Government’s budget, but tax rates should not be so high as to

discourage work or encourage tax arbitrage between corporate and personal

tax. These are very complex and challenging issues for policy makers. As

previously indicated the Committee is of the view that the current tax rates are

too high and believes this discourages workers from saving and from doing

extra work.

Non-resident Tax Rates

The issue of the tax rates for non-residents was only directly raised in one

submission.15 The submission suggested that the top marginal rate should be

increased to 48 per cent for non-residents. As noted earlier, the PIT applies

different tax rates and thresholds to non-residents. Non-residents are not

entitled to the tax-free threshold and face a slightly different tax scale.

While it may be that non-residents have a higher earning capacity than

residents, the Committee is not attracted to increasing marginal tax rates for

one taxpayer group. However, any move to harmonise resident and non-

resident tax rates would have a revenue cost thus would need to be carefully

considered. That said, having common tax rates would reduce the complexity

of the PIT system for employers and employees.

Income Tax Bands

Associated with marginal tax rates is the number of tax bands and the income

levels at which they apply. Some submissions suggested changes to the tax

bands, commenting that the current allocation seem arbitrary or unnecessarily

complex. One submission expanded on this particular point by arguing for a

14 JAJ Associates, 30 April 2014. 15 Steven Paisi 3 June 2014.

Page 21


more radical overhaul of tax bands to include a flatter structure with only two

(2) tax bands and a separate threshold for income earned from SMEs.16

Income tax bands are designed to provide a degree of progressivity in the

collection of tax. That is, the more you earn the more you pay in tax both in

absolute terms and as a percentage of income. Whether the current bands and

their starting and ending points meet this objective is a matter for examination.

In that context one of the challenges with flatter income tax structures is that

equity and fairness issues can come more to the fore.

One issue associated with the location of tax bands, as well as the marginal tax

rate, is their impact on productivity at the margin. Once a worker exceeds a

particular threshold they face a higher rate of tax on any income above that

threshold. For example, for income between K10,000 and K17,999 the current

tax scales apply a tax rate of 22 per cent, which most people have argued is too

high for PNG’s low income workers.

Several submissions suggested simplifying the income tax system by reducing

the number of bands or spacing them more appropriately.17 While the 6

marginal rate bands within the current tax system deliver a progressive tax

pathway, this could also be achievable with fewer bands, although their

location and the marginal tax rate attached to them will require careful review.

Tax on Termination Pay

The Committee received submissions on the narrow application of the current

concessional arrangements or suggested special tax treatment for certain

employees, such as public servants.18 Other submissions suggested

concessional treatment for retirements on medical grounds, and consistent

treatment of termination payments in respect of staff engaged before and after

1993.19 Further comments were received on reducing the rate of tax on eligible

termination payments and on final payments of annual leave, long service

leave, retention payments and the like.20 As covered earlier in this paper,

termination payments are taxed as ordinary income unless they fall under an

approved redundancy scheme.

16 National Research Institute 14 November 2014. 17 Chris Smith 31 March 2014, Adam Smith International 23 April 2014. 18 Clement Korken, 8 May 2014; Bank of South Pacific Ltd, 12 May 2014; KTK Accountants and

Associates, 14 May 2014. 19 JAJ Associates, 30 April 2014, BPNG, 6 May 2014. 20 Bank of South Pacific 12 May 2014; KTK Accountants and Associates 14 May 2014.

Page 22

PNG’s current taxation of redundancy benefits is complex because the

individual components are subject to different tax rates. The concessional

arrangements require that redundancy be approved by the Commissioner

General and must involve a minimum of 30 employees being made genuinely

redundant. Submissions received by the Committee suggested that this

condition was too onerous and that a fewer number of employees should be

entitled to the tax concessions. Moreover, the lower rate of tax should apply to

all entitlements received not just the redundancy component.

Retirement Savings

While employer contributions are made pre-tax, employee contributions to

superannuation funds can only be made from after tax income. Further, the

earnings of superannuation funds are taxed as are withdrawals, although

funds of up to K250,000 can be transferred to RSAs. Savings in RSA in accounts

can be drawn down periodically free of income tax, providing an income

stream in retirement. Withdrawals in excess of prescribed limits are taxed at 30

per cent.

Submissions generally fell into three (3) areas. The first concerned encouraging

an increase in savings into superannuation. The second dealt with

administrative issues around superannuation and the third, the taxation of

superannuation.

Increase in Superannuation Contributions

Submissions received suggested that the current caps on employer

contributions to superannuation (which are paid pre-tax) should be increased

to encourage savings.21 The submissions argued that an increased level of

superannuation savings by employers and employees is necessary to provide

for a reasonable retirement. One submission suggested that the minimum

payment into superannuation should be 20 per cent.22

Questions about the adequacy of superannuation savings are important and

require careful consideration. Whether the pool of superannuation is sufficient

for the future retirement needs of employees depends upon a number of

interconnected matters including the role of government in providing income

support, the anticipated returns from superannuation funds, likely income

21 See submissions from Bank of South Pacific, BPNG, Association of Super Funds PNG. 22 Association of Superfunds PNG 2 May 2014.

Page 23


needs in the future as well as question of longevity of retirees and employment

participation rates.

The Committee notes that the current tax treatment of superannuation has

raised questions about whether the tax treatment of superannuation is

appropriate given the number of points at which funds in superannuation are

taxed. The treatment of retirement incomes is further discussed in Chapter 9.

Contributions by Employers to an Overseas based Superannuation

Suggestions were made to the Committee that contributions to superannuation

made by non-residents and their employers should be directed to PNG based

superfunds.23 The argument is largely one based on nation building rather

than tax. That is, PNG should get the benefit of the payment of superannuation

on behalf of non-resident workers through a requirement that these funds be

invested in a PNG based superannuation fund. Funds would remain in PNG

superannuation funds until such time the non-resident leaves the country

permanently. At that time the funds would be returned to him or her.

Other jurisdictions, such as Australia, do have a requirement that employees

working on temporary work visas are required to contribute super guarantee

payments into an Australian supervised superannuation fund. The money is

subsequently released on the employee’s permanent departure from Australia.

However, the Committee notes that the current tax law already provides a

bias to local funds because contributions to foreign superfunds are not tax

deductible to the employer. Consistent with the comment above, the

submission by the Bank of Papua New Guinea recommended that changing

the law on this point was not desirable.

Reduce the Tax on Superannuation Contributions, Earnings and Benefits.

Several submissions made recommendations to reduce the tax paid by

superannuation funds on their earnings or otherwise make certain investments

tax free, such as investments into preference shares or Government stock and

securities with a maturity in excess of 12 months. Superannuation funds

currently pay 25 per cent tax on their earnings. However, they receive a rebate

on dividends (to cover the tax otherwise payable) and they are also exempt

from dividend withholding tax.

23 BPNG, 9 May 2014.

Page 24

Superannuation Payouts

Submissions raised the issue that as superannuation is taxed in the

accumulation stage then it should be tax free on draw down. This issue is

similar to proposals mentioned in other submissions to reduce the overall

taxation of superannuation funds. Chapter 9 explores this issue in the context

of alternative approaches to taxation.

Tax on Benefit on Death of Member

It has been suggested to the Committee that the current tax rate of 2 per cent

on the benefit pay out on the death of a member should be reduced to 0 per

cent.24 The Committee notes that this rate is already a concessional rate

compared to the tax levied on superannuation payouts generally.

Housing Advances from Superfunds

Several submissions made suggestions on changes to the use of advances from

superannuation accounts for the purchase of homes, and to align the

thresholds with that for stamp duty exemption.25 Under the current law, to

qualify the home must be under K400,000. Stamp duty exemption is available

for homes under K500,000.

Taxation of Pensions

The Association of Superannuation Funds raised the proposal that pensions

funded from superannuation savings should be exempt of income tax.

However, the Committee considers that instead of designing concessions

around the taxation of pensions, most people who receive pensions would

equally benefit from changes to the tax free threshold and marginal tax rates.

24 BPNG 9 May 2014. 25 BPNG, Bank of South Pacific, Association of Superannuation Funds PNG.

Page 25


Tax Treatment of RSAs

The Association of Superannuation Funds argues that there is inconsistent tax

treatment between taking money from superannuation as a lump-sum and

using RSA accounts. The argument is that in some situations, only 2 per cent

tax will be paid on lump-sum payments whereas withdrawals from RSAs that

exceed the prescribed limits attract a 30 per cent tax liability.

Tax Treatment of over 55s and the Age of Retirement

Suggestions were made that the retirement age should be raised to 60, to

encourage further savings, and to provide tax free treatment for retirement

income once a person reached the current retirement age of 55. The latter

argument is about providing tax incentives for employees not to take their

superannuation before they turn 55. Regarding the age of retirement, the

Committee believes that this issue is beyond the terms of its reference.

Page 26

CHAPTER 4: OPTIONS FOR REFORM OF THE TAX

FREE THRESHOLD AND PERSONAL INCOME TAX

RATES

This Chapter describes the Committee’s analysis and reform proposals for

personal income tax rates, thresholds, and termination payments.

The Committee’s starting point is that the tax system exists to raise revenue,

for the government to provide services for the benefit of all PNG citizens. As

canvassed in the Committee’s Issues Papers, the country’s tax system’s design

should be based around basic design principles of revenue mobilisation,

competitiveness and efficiency, fairness, simplicity, trust in and accountability

of government. Addressing the concerns of some workers by introducing new

concessions is not consistent with these principles or the direction of reform

the Committee is pursuing. Rather, the remuneration concerns are best

addressed through budget allocations.

Tax Free Threshold

The current tax free threshold of K10,000 was introduced in 2012 as part of

changes to marginal tax rates. The tax free threshold is part of the

progressivity of the PIT system. This is because it contributes to reducing tax

paid, as a percentage of income, which is at its greatest for low and medium

income earners.

The Committee’s analysis of personal income tax burden in PNG is that it is

high when compared to neighbouring countries. As a general proposition,

receipts from PIT are relatively low in most low income economies, historically

between 1-3 percent of GDP; compared to 9-11 percent for high income cum

developed countries.26 In this context, PNG’s current collection of around 8

per cent is high for a low income country and displays the focus of the tax

system on wage and salary workers in formal economy as well as the

26 Peter, Klara Sabirianova, Steve Buttrick, and Denvil Duncan, 2010, “Global Reform of Personal Income Taxation, 1981-2005: Evidence from 189 countries”, National Tax Journal, Vol. 63, pp. 447–78.

Page 27


significance of government employment and other major employment sectors.

The following table compares tax free thresholds in the region.

Table 3: Regional Comparison of Tax Free Thresholds

Country Tax-free threshold

(in local currency)

2013 GDP per

capita (in

local currency)

Ratio of tax free

threshold and GDP

per capita

Tonga 7,400 7,984 0.9

Solomon

Islands

15,080 15,271 1

Samoa 12,000 8,523 1.5

Fiji 16,000 8,653 1.9

PNG 10,000 4,806 2.0

Sources: IBFD, Ministries of Finance, Article IV data and consultant calculations

The tax free threshold in PNG, as a ratio to GDP per capita, is similar to that in

Fiji and to a lesser extent Samoa. But these comparisons should be treated with

some caution given the differences between the economies and the reliability

of the GDP estimates. For example, PNG is a resource rich country with a

significant level of mining and government employment. Consequently it may

be possible that PNG’s reported GDP is understated.

Another consideration in evaluating the tax free threshold is the income

distribution of taxpayers in the PIT system. The distribution can provide useful

information about how the tax system interacts with wage and salary earners,

particularly low income workers. The distribution shown in Table 2 in Chapter

2 indicates that a large number of taxpayers at low income levels pay very little

tax.

This creates an unnecessary administrative burden on taxpayers and the IRC

given so little revenue is collected from these taxpayers. Using the 2014 survey

data, almost 36 per cent of employees earned less than K14,000. Based on

reported tax receipts, those earning less than K14,000 contributed less than 2

per cent of total PIT paid in 2014.27

27 Committee estimates using 2014 survey result.

Page 28

The Committee has considered these issues and considers that an increase in

the tax free threshold is warranted. An increase will assist in addressing

bracket creep that has arisen since the threshold was last increased in 2012. It

will reduce complexity by removing lower income workers from the tax

system and produce tax relief for all income earners. While it is a matter of

judgement, the Committee believes that the tax free threshold should be

increased to a level that removes, as far as feasible, low income earners from

the tax system. Based on the 2014 data, increasing the tax free threshold to

K15,000 would remove over 36 per cent of employees from paying personal

income tax. Increasing the threshold to K20,000, would see 44 per cent of

employees no longer be subject to personal income tax.

Of course raising the tax free threshold will come at a cost to the revenue levels

of the Government. For example the revenue cost of a tax free threshold of

K15,000 will be in the hundreds of millions of Kina. This is because without

adjustments in the marginal tax rates, the benefits of increasing the tax free

threshold, flows to all taxpayers. This forgone revenue will have to be

recovered from a package of reforms that could include reductions in tax

concessions, removal of rebates, as well as an increase in the GST. To manage

the revenue consequences, a staged approach is critical and is necessary where

the tax free threshold is initially increased to K15,000 and then later to K20,000,

as the package of tax reforms are implemented.

Question 4.1 –Do you agree that adjustment to the tax free threshold is the best

mechanism to give tax relief? Do you have any views on whether adjustments

to individual marginal tax rates could provide a similar level of relief? And if

so, what changes could be made?

Question 4.2 –What is your response to the Committee’s observation that the

tax free threshold could be raised to at least K15,000 as part of a package of

possible reforms that include reductions in concessions and removal of rebates

and an increase in the GST?

Marginal Tax Rates

The current PNG tax schedule has 6 bands from 0 per cent to 42 per cent. This

is part of the progressivity of the tax system so that those who have the

capacity to pay, contribute more. Yet the income thresholds for the middle tax

brackets (30, 35 and 40) have hardly changed. The 30 per cent bracket was re-

introduced in 2006 and the threshold for the 35 per cent rate was increased at

the same time. As a result, inflation has caused the real income thresholds for

Page 29


the 30 per cent and 40 per cent rates to fall steadily over time, and the real

threshold for the 35 per cent rate has also fallen since the threshold change in

2006. This has resulted in bracket creep, increasing the tax burden on middle-

and high-income earners, particularly for those with incomes above K33,000

per year.

It has been suggested in submissions that the Committee’s review of marginal

tax rates be guided by comparisons between PNG and other countries in the

region. The Committee agrees that such comparisons provide useful

information, although caution has to be exercised given gaps in the available

data and the understanding and appreciation of the differences in the

methodologies used to evaluate tax burdens. Submissions received also argued

strongly that the current marginal tax rates were imposing a significant tax

burden on wage and salary earners.

The Committee has taken the view that changes to the PIT should be targeted

so that the benefit of the reduction in income tax is greatest for those on low

and middle incomes. Significant reductions in the marginal tax rates on top of

changes to the tax free threshold will have major budgetary implications. The

Committee’s analysis indicates that high income earners (those earning over

K150,000 per annum), contribute approximately half of personal income tax

collections.

Table 4 Regional Comparison of PIT Rates

Country Resident Tax Rates

(in percent)

PNG 0, 22, 30, 35, 40, 42

Australia 1 0, 20.5, 34, 38.5,46.5

Fiji 2 0,7,18,20,

New Zealand 3

Samoa

0,12.2,19.2, 31.7,34.7

0,10, 20, 27

Solomon Islands 0,11,23,35,40

Tonga 0,10, 20 1 Australian rates include the Medicare levy. 2 Above FJ$ 270,000 -a social responsibility levy applies, with rates of 23, 24, 25, 26, 27, 28 and 29

per cent. 3 Includes ACC earners levy.

Page 30

Source: Ministries of Finance, IBFD

Table 4 indicates that PNG generally has higher tax rates on individual income

bands and has more income tax bands. How the marginal rates interact to

produce the average tax paid by employees is shown in Chart 3.

Chart 3 Average tax paid 2000-2012

Source: Committees own calculations

Chart 3 shows the average real personal income tax paid between 2000 and

2012. Each line represents the average tax paid associated with changes to the

tax rates in the years indicated. The chart shows that over that time, the slope

of the line has changed little and if anything, has become slightly shallower as

the tax free threshold has increased during that time and marginal tax rates

adjusted. As the line is relatively straight (reflecting the earlier point that few

changes have been made to rates and income thresholds), it can be argued that

the PIT is quite efficient in progressively increasing average tax paid as

incomes rises.

The Committee is of the view that the current progressivity of income tax rates

should be maintained, although there could be scope for reducing the number

of steps, consistent with the experience of other countries where the number of

tax bands has been reduced (OECD 2006). Furthermore, introducing a tax mix

switch from PIT to the GST and other taxes will provide scope to maintain

PNG’s GDP share of tax revenue while providing tax relief to wage and salary

earners.

0

20,000

40,000

60,000

80,000

100,000

120,000

0 50,000 100,000 150,000 200,000 250,000 300,000

2000

2001

2002

2006

2007

2008

2012

Page 31


Question 4.3 – What are your views on maintaining the progressivity of the

existing marginal tax rates but with adjustments reflecting changes to the tax

free threshold and the number of tax bands?

Top Marginal Tax Rate

The top rate and threshold (42 per cent above K250,000) have been stable since

2007 and so bracket creep has caused an increased tax burden for high income

earners. However, both the rate and threshold changed several times before

2007. In most cases, these changes reduced the impact of the top rate, either by

lowering the rate itself (from 47 per cent, to 45 per cent and finally to 42 per

cent) or by increasing the income threshold (from K95,000 to K150,000 and

then to K250,000).

The Committee acknowledges concerns about the relatively high top marginal

rate of 42 per cent but believes that reform is more urgently needed for low

and middle income earners. But, there are good reasons to reduce this rate

going forward to improve the attractiveness of PNG as a place of employment

for highly skilled workers. As any reform of the top marginal tax rate will

have revenue consequences given the significant contribution that high income

earners make to overall PIT revenue collection. The Committee, therefore,

considers that any change to the top marginal tax rate be part of a second stage

of reform of the PIT. Ideally, consideration of reducing the top marginal rate

could be undertaken alongside reforms to the corporate income tax rate

discussed in Issues Paper No. 2.

Question 4.4 – What are your views on the Committee’s proposal that the

current top marginal tax rate be retained for the present time?

Question 4.5 – Do you agree with the proposal that future reductions in the

top marginal tax rate be considered in conjunction with reductions to the

corporate tax rate?

Income Tax Bands and Rates

Associated with top marginal tax rate is the number and income level at which

the other marginal tax bands apply. Some submissions suggested changes to

the tax bands, arguing that the current allocations seem arbitrary or are

unnecessarily complex. Income tax bands are designed to provide a degree of

progressivity in the collection of taxation. Therefore the number of tax bands,

Page 32

their marginal tax rate and the level of income at which they take effect are

important tax policy questions or considerations.

One issue associated with the location of tax bands, as well as the marginal tax

rate, is their impact on productivity at the margin. Once a worker exceeds the

tax free threshold they face taxation on any income above that threshold. For

example, for income between K10,000 and K17,999 the current rate is 22 per

cent, which some submissions argue is a disincentive for low income workers

and to workers moving from the informal to the formal employment.

Chart 4 Nominal marginal tax rates

Source: Tax Committee calculations

Chart 4 illustrates the changes to marginal tax rates (MTRs) between 2000 and

2012. Over this time, changes to MTRs have only varied slightly with the major

change being in the tax free threshold which has increased from K4000 in 2000

to K10,000 in 2012. One consideration is whether the shape of the curve

associated with MTRs is too steep over the lower income bands and therefore

whether adjustments should be made to provide greater relief at lower income

levels and less at high income levels. On this point, several submissions to the

Committee have suggested simplifying the income tax system by reducing the

number of bands or spacing them more appropriately.28

The Committee is attracted to suggestions regarding the number of tax bands,

provided reducing the complexity does not reduce progressivity and fairness

28 Chris Smith 31March 2014, Adam Smith International 23 April 2014.

0%

10%

20%

30%

40%

50%

60%

0 20,000 40,000 60,000 80,000 100,000 120,000

2000

2001

2002

2006

2007

2008

2012

Page 33


in PNG’s tax system. For example the current 6 tax bands could be reduced to

four (4). Fewer tax bands would reduce administrative costs and compliance

complexity as well as increasing incentives to work through changes in the

income points at which marginal tax rates take effect. It can be further argued

that a simplified tax rate structure would reduce the incentives for tax

evasion.29

Question 4.6 – Do you have a view on whether the number of tax bands

should be reduced in number? If so what tax bands are appropriate for PNG?

Question 4.7 – Do you have views on what the marginal tax bands should be

and at what income levels should they apply?

Non-resident Tax Rates

As discussed earlier in this paper, there are differences in the tax rates

applying to residents and non-residents. A comparison between resident and

non-resident PIT is shown in Chapter 1, Table 1 wherein the non-resident

component is repeated in Table 5 below. It is not unusual for countries to

impose different tax rates on the basis of residency. One argument used to

support such differentiation is that non-residents are only taxed on their PNG

income, whereas residents are taxed on their worldwide income.30

Table 5 Non-resident tax rates

Non-residents

Taxable income

(K)

Tax

(K)

Rate on excess

%

Nil Nil 22

18,000 3,960 22

33,000 8,460 30

70,000 21,410 40

250,000 93,410 42

29 Adam Smith International, 23 April 2014. 30 http://comparativetaxation.treasury.gov.au/content/report/html/12_Chapter_10-03.asp

Page 34

Although there was little feedback during the consultation process for reforms

to non-resident tax rates, there was a suggestion that the top marginal tax rate

on non-resident taxable income should be increased. The Committee is not

attracted to this idea.

Any increase in non-resident tax costs will directly impact on the cost of

employment and this will flow through to the economy. It can be expected

that non-residents will focus on their after tax income and employers

recognising this, will gross up salaries to offset the effects of non-resident tax

rates. Rather than the higher taxes on non-residents providing a strong

positive return to government revenue, the grossing up of salaries will be

translated into higher employment related deductions for companies.

Therefore it is likely that any increase in non-resident PIT revenue will be

offset by a fall in company tax receipts.

Consequently, there is some doubt as to whether the different tax rates

between residents and non-residents can be justified on a revenue collection

basis. There may also be economic benefits associated with removing barriers

to people working in PNG. The ITA will also be simplified. The Committee

notes that New Zealand has already moved in this direction. The Committee

therefore proposes that resident and non-resident tax rates and thresholds be

harmonised as part of an overall package of tax reforms in PNG.

Question 4.8 – To what extent are non-resident salaries likely to be grossed

up?

Question 4.9 – Do you agree with the Committee’s recommendation that

resident and non-resident tax rates and thresholds should be harmonised?

Page 35


CHAPTER 5: OPTIONS FOR REFORM OF THE TAX

ON TERMINATION PAYMENTS

The current tax treatment of termination payments has its origins in

concessional tax treatment of gratuities paid to public servants in the 1970s.

These were gratuities designed to encourage retention of staff: after two (2)

years’ service, public servants qualified for a 20 percent of salary gratuity (the

rate increased every two (2) years, but was capped at 40 per cent.) The tax on

these gratuities was a flat 2 per cent. This gratuity and the concessional

treatment applied to (uncapped) retirement and redundancy payments.

These arrangements were removed in 1992 as a package of savings to fund a

general reduction in tax rates. Following public pressure the concession was

restored shortly afterwards but only for redundancy payments. Consequently,

the policy basis for the concession is unclear. In this context termination

payments are taxed under the ITA as ordinary income unless they fall under

an approved redundancy scheme, where concessional taxation arrangements

apply.

In response to the public consultations the Committee has received a number

of submissions covering the issues on termination payments. In particular, on

the narrow application of the current concessional arrangements or suggested

special tax treatment for certain employees, such as public servants.31 Other

submissions suggested concessional treatment for retirements on medical

grounds, and consistent treatment of termination payments in respect of staff

engaged before and after 1993.32 There were further comments regarding

reducing the rate of tax on eligible termination payments and on final

payments of annual leave, long service leave, retention payments and the

like.33

Early Retirement on Medical Grounds

One submission to the Committee proposed that medically induced

retirements should be subject to a concessional tax rate. The ITA already

31 Clement Korken, 8 May 2014; Bank of South Pacific Ltd, 12 May 2014; KTK Accountants and

Associates, 14 May 2014. 32 JAJ Associates, 30 April 2014, BPNG, 6 May 2014. 33 Bank of South Pacific 12 May 2014; KTK Accountants and Associates 14 May 2014.

Page 36

provides for significant tax concessions regarding superannuation payouts on

death or the permanent disablement of the employee. In considering whether

the tax concessions for redundancy payments should be further reduced for

early retirement on medical grounds, the Committee has looked to

international experience.

There are examples of the tax treatment of redundancy benefits being more

concessionally taxed if the termination is due to a medical condition. Australia

has a provision in its tax law which applies if an employee has been made

redundant due to invalidity. 34 The effect of the concession is to provide tax free

treatment to that part of the termination pay which reflects the difference

between the employees actual length of employment compared to if the

employee had continued until his or her usual retirement date. 35 In contrast,

New Zealand does not provide any concessional tax treatment for such

payments. There are also several examples of superannuation schemes

providing early access to retirement pensions where the taxpayer has a

medical condition that prevents them from continuing to work.36

Given the absence of a common approach internationally and a policy

rationale in PNG, the Committee is not convinced that specific tax concessions

for medically induced retirements is desirable. Any new concession will add

complexity to the law is inconsistent with comprehensive income taxation and

will require integrity measures to avoid manipulation.37

Question 5.1 – Should the taxation of redundancy payments in cases of

medically caused retirements be taxed more lightly? What do you think the

policy rationale should be for reducing tax on redundancy payments in this

situation?

30 Employee Limit

The Committee received comments that the operation of Section 46CA of the

ITA. This section provides concessional treatment for certain redundancy

34 https://www.ato.gov.au/printfriendly.aspx?url=/individuals/working/in-detail/leaving-a-

job/Taxation-of-termination-payments/#Invalidity_formula. 35 In Australia it is assumed that the retirement date would be when the taxpayer reached 65

years of age. 36 Examples include Australia, Canada and the United Kingdom. 37 Australia allows access to superannuation lump sums that would otherwise not be permitted,

in situations of the imminent death of the taxpayer. This requires two (2) doctors to certify that the taxpayer has a terminal condition that will result in death within 12 months.

Page 37


payments for private sector redundancies involving 30 or more people. Public

sector redundancies are also covered although the 30 person threshold does

not apply. The provision also requires a minimum of 5 years continuous

service with the employer. The argument in favour of the 30 person threshold

is that it provides an objective threshold above which a genuine redundancy

situation can be said to exist. If the threshold was lower or absent then the

opportunity would exist for employees to plan redundancies in order to access

concessional tax treatment for their termination payments. While the integrity

risks are real, the threshold is arbitrary and its design questionable given that it

is not applied to public service redundancies.

The Committee agrees that the logic behind the taxation of ex gratia payments

under Section 46CA is not strong. The current arrangements create inequality

and hardship between private and public sector employees and between

genuine redundancies who are able to access the concession and those who

cannot. A first best approach would be to remove the current concessions.

However, in light of the existing concessions and the argument that

termination benefits are a form of temporary income support, the policy

objective should be to achieve consistent tax outcomes regardless of the scale

of the redundancies or whether the employer is government or private.

Question 5.2 – Should Section 46CA be amended to remove the 30 person

redundancy requirement as discussed? If so what integrity measures should

be applied to ensure only genuine redundancy is covered?

Support for Reform of the Taxation of Termination Payments

It is clear from submissions that the current tax arrangements have a degree of

taxpayer support. In reviewing international practice it seems that most

countries around the world, with the exception of some low income countries,

require termination payments of one form or another. The rationale behind

providing such payments may have a number of origins from income support,

improving labour mobility to job protection. 38 There is also some international

evidence of tax concessions being applied to the taxation of these payments.

The following arguments can be made in favour of the existing tax concessions

for redundancy payments. The first is that concessional tax treatment of

38 Holzmann R, Pouget Y, Vodopivec M, Weber M. Severance Pay Porgrams around the World:

History, Rationale, Status and Reforms. World Bank May 2011.

Page 38

redundancy payments is necessary to ensure that the progressivity of PIT does

not result in an unfair amount of tax being paid compared to if the payments

had been made over a period of time. The strength of this argument is

weakened however by the existence of the cap of K50,000 (assuming 23 years

of continuous employment with the one or related employer). The second is

that in the absence of government income support payments, taxing at a too

high a rate would also undermine the value of termination payments as

assistance for employees during periods of unemployment, when or where no

income will be earned.

In countries where there are robust social security systems, tax concessions are

transfers between the social security and tax systems. In PNG this is not the

case because there is no government income support provided to those who

are unemployed or retired. Based on this logic, there may be good reason for

the taxation of redundancy payments to depart from the comprehensive

income approach of taxing all economic income because to do otherwise

would transfer the cost of redundancy from the government to taxpayers’

families.

The Committee, while appreciating the comments made in submissions,

believes the goal of the tax reform process should be to lower rates and

broaden the tax base rather than maintain exemptions and concessions. The

first best solution would be to remove the current tax concessions and use the

revenue saved to lower income taxes generally. The current tax concessions

result in tax rates being higher than they might otherwise be and reducing

income tax rates will also have the benefit of reducing the tax applied on

termination payments.

However, the Committee acknowledges that implementing a first best

approach is difficult and that the history of the current concessions needs to be

recognized. However, the current approach in the ITA lacks consistency as the

concessions have evolved over a period of years in response to the specific

issues that have arisen rather than as part of a broader policy response.

An alternative is to reform the taxation of termination payments to provide

consistency and simplification. This would assist both the taxpayer and the

IRC. However, the extent to which such changes make the taxation of

termination benefits more or less concessional is a matter of judgment.

Two approaches, among others, could be considered.

Page 39


The first is to amend the operation of Section 46CA so that a base amount of

termination and redundancy payments is subject to concessional tax treatment.

The distinction between redundancy and termination, private and public

sector employees along with the 30 person threshold would be removed. The

current threshold of K50,000 (or some other amount) would be applied to all

termination payments. Payments up to the threshold would attract a flat tax

rate of 15 per cent. Amounts above the threshold would be taxed at the

appropriate marginal tax rate.

The second would be to apply concessional tax rates based on age and service

based criteria. For example, borrowing elements from the current tax on

superannuation withdrawals, concessional rate of 15 per cent would be

available for all components provided the employee had a minimum of 5

years’ service with their employer. Once an employee has 15 or more years’

service, a concessional rate of 8 per cent would be applied.

For both, these approaches will require imposition of some additional integrity

measures. A cap on the maximum kina value of termination payments would

be advisable regarding the second option to address integrity concerns and to

limit revenue loss. Other measures may be needed to ensure only genuine

redundancies are captured. Again these options would need to consider how

to best deal with long service leave, given the existing tax concession for pre

1993 components.

Consequently, the Committee believes that there is merit in modifying the

existing tax treatment of termination payments to provide a simpler

standardised approach to the taxation of termination payments.

Question 5.3 – If concessions are to remain, should Section 46CA be replaced

by a simple Kina cap on the amount of termination payments subject to the

concession?

Question 5.4 – Should the taxation of termination payments be determined

according to the length of service an employee has with his/her employer?

Should the age of the employee be another consideration when providing tax

concessions?

Question 5.5 – Should long service leave be included in any new arrangements

or should it continue to be taxed under the existing tax rules?

Page 40

CHAPTER 6: REFORM OF REBATES AND CREDITS

Rebates and credits are allowed against gross tax assessed on taxable income. 39

The concessional rebates allowable are dependants, education, election

expenses, non-salary or wages loss and gifts or donations. Credits allowable

are interest withholding tax, business payments withholding tax and royalty

withholding tax including foreign tax paid by a resident.

Rebate on Dependents

Concessional rebates relating to dependants are covered under Division 18A,

Section 213A – Section 213F of the ITA. The number of dependants is limited to

three (3) with a maximum rebate of K450 for the first dependant and K300 for

the second and third dependants, a total of K1,050. The minimum rebates are,

K45 for the first dependant and K30 each for the second and third dependants,

a total of K105. The dependant rebate is allowable only to resident taxpayers.

For employed persons, the number of dependants is taken into account by the

employer when computing PIT to be deducted from their salary or wages. For

the self-employed or deriving business income, including income received

from partnership income, the dependant rebate is offset against the gross tax to

work out the tax payable.

Given the large family sizes in PNG it could be expected that the dependent

rebate would be heavily used. However, evidence from the IRC suggests that a

majority of people are not claiming the full 3 dependents. Submissions to the

Committee suggested that the definition of dependent is too narrow (as a

result confusing) because it classifies dependents as:

a spouse,

a child less than 16 years of age,

a student child,

39 Under Section 4 of the Income Tax Act, assessable income is „the amount remaining after

deducting from assessable income all allowable deductions”.

Page 41


invalid relative being a person who is not less than 16 years of age and

is a child, brother or sister of the taxpayer or

a parent of the taxpayer or of his/her spouse, where the parent is a

resident of PNG.

Given the role of families and community in the lives of Papua New Guineans

it may be that this definition of dependent has reduced access to this

concession, perhaps explaining its limited utilisation. Consequently it may be

better to address the costs associated with dependents through lower taxes

rather than by providing a tax concession. Further analysis is needed on how

much rebate is being claimed.

Question 6.1 – For the purpose of simplifying the system for PIT and business,

should the dependants rebate be abolished and folded into the standard tax

rates?

Rebate on Education Expenses

Rebate on education expenses is covered under Division 19, Section 214B of the

ITA. Under this provision, parents can claim rebate for paying school fees for

dependent children attending primary or high schools within or outside PNG.

The rebate is limited to the lesser of 25 percent of the net education expenses

incurred or K750 per dependent child.

Page 42

Chart 5 Refund of education expenses 2004-2013

Source: IRC

Data from IRC indicates that only K73,000 was spent on school fee refunds in

2013 giving rise to the question of whether providing this rebate is useful. To

claim the rebate the taxpayer has to lodge an income tax return for the year the

school fee was paid. Since the deduction of PIT is a deemed assessment for

salary or wages tax, under section 228(2), an amended assessment will issue

indicating amount refundable followed by the refund cheque payment. This

amendment must be done before expiration of six years after the close of the

year in which the school fee was paid.

Submissions received by the Committee raised a number of issues. One of the

submissions received stated that the refund process for education rebate takes

too long. (NOTE: this is indeed a very common reason given by ordinary

PNGeans!). Other submissions raised concerns that the K750 maximum rebate

is not enough for parents who send their children to international schools,

which charge very high school fees and which are not covered by the free

education policy of the PNG Government. While noting this concern, the

Committee is of the view the cost of sending of children to private and

international schools is a choice made by parents.

Page 43


The Committee is of the view that the education rebate should be abolished

and the saving rolled into a reduction of marginal tax rates. The Committee

also notes that the 2000 Tax Review made a similar recommendation.40

Question 6.2 – What are your views on removing school fee rebate and rolling

the savings into lower tax rates?

Rebate on Salary and Wage Expenses

Under Section 214(1)(a)(i) of the ITA, employees who incur losses or outgoings

in the course of deriving salary and wages income, can claim a rebate. The

rebate is calculated as 25 per cent of the losses or outgoings that exceed

K200.00 in a year. Data from IRC suggest nearly K477,000 was refunded in

2013 with the highest amount in 2004 and the lowest amount in 2012.

Chart 6 Salary and wage rebate

Source: IRC

The above chart indicates that claims for wage and salary expenses have been

declining over the past decade. The reason for this trend is not very obvious.

However, the K200 threshold may act as a disincentive as taxpayers need to

40 See Report of the Taxation Review, summary of recommendations.

0

200000

400000

600000

800000

1000000

1200000

1400000

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

Val

ue

of

sala

ry a

nd

wag

e e

xpe

nse

re

bat

e

Year

Rebate claimed (Kina)

Page 44

seek an amended assessment in order to claim salary and wage expenses above

the threshold. As the use of the rebate is declining, removing it would appear

to be a logical step to streamlining the tax system. The individual taxpayers

disadvantaged by the removal of the rebate, will benefit from the overall

lowering of the income tax burden.

Question 6.3 – Do you support the removal of the salary and wage expenses

rebate and rolling the savings into lower tax rates?

Rebate on Election Expenses

The deductibility of election expenses is provided for under Section 96 of the

ITA. Besides claiming the expense as an outright deduction against non-salary

and wage income, the expenses can be claimed as a rebate under Section

214(1)(a)(ii) of the ITA. The rebate allowable is limited to 25 per cent of the

election expenses incurred. One submission to the Committee suggested that

this deduction is unfair because ordinary taxpayers do not have access to a

similar rule regarding their expenses.41

41 Chris Smith 31 March 2014.

Page 45


Chart 7 Election expense claims

The provision of deductibility for election expenses is not unique. It is directly

related to employment costs and several jurisdictions allow such deductions.42

Nor do those seeking political office have access to deductions under PNG tax

laws which are excessive because election expenses are capped at 25 per cent of

the costs incurred. Moreover, any reimbursement provided by any person or

organisation for election expenses allowed or allowable must be included in

the taxpayer’s assessable income.

PNG’s democratic processes are hugely respected so, the Committee believes

that the election expense rebate can be distinguished from the other rebates

because of its importance to participatory democracy in PNG. Consequently,

the Committee believes that the rebate should be retained.

Question 6.4 –Do you agree with the Committee’s reasoning that the election

expenses rebate be retained?

Rebate on Non-Salary or Wage Loss

Non salary or wages loss under Section 214(4) of the ITA allows salary or wage

earners who receive PNG sourced non-salary or wage income to claim this

42 For example Australian Taxation Office Taxation Ruling TR 1999/10.

0

200000

400000

600000

800000

1000000

1200000

1400000

Val

ue

of

sala

ry a

nd

wag

e e

xpe

nse

re

bat

e

Year

Rebate claimed (Kina)

Page 46

rebate. By claiming a rebate, the losses incurred cannot be carried forward to

be recouped against future income. Losses associated with overseas sourced

income do not qualify for the rebate.43 Such losses are carried forward and

offset against future income from sources outside PNG.

The Committee did not receive any direct submissions on this subject matter

but is interested in stakeholders’ views on whether this rebate should be

abolished to help simplify the income tax system. The Committee notes that

any abolition would be in the context of overall reductions in PIT.

Question 6.5 – Do you support the removal of the rebate on non-salary and

wage loss?

Tax Credits

Income assessable under ITA can be subject to double taxation and foreign

withholding taxes. The ITA provides relief from double taxation in the form of

a tax credit for overseas tax paid. However, some of these withholding taxes

are final taxes so the taxpayer is not required to include the income in

assessable income.

Foreign Income Credit

Relief from double tax is an important international tax principle that has

evolved with the rise of international trade and investment. There are two (2)

approaches that can be adopted to deal with income that is taxed in another

jurisdiction. The first is to include the foreign sourced income in taxpayer

assessment and credit the foreign tax paid. The second is to exempt the foreign

sourced income from domestic taxation on the basis that it has already been

taxed.

To avoid double taxation, resident taxpayers, whose assessable income

includes income derived from worldwide sources, are allowed foreign tax

credit under Section 219. This credit is used to offset the PNG tax on the

taxpayer’s worldwide income to the extent that any overseas income has

already been taxed in that other jurisdiction.

Question 6.6 – Do you support the current arrangements in the ITA for the

relief of double tax?

43 Section 66A (3) of the ITA.

Page 47


Withholding Taxes

Interest, dividend and royalty withholding taxes were discussed in Chapter 1.

More detailed discussion can be found in Issues Paper No. 2 on Corporate and

International Taxation and in the Issues Paper on Mining and Petroleum

Taxation regarding royalty withholding tax for landowners.

The Committee received a few submissions in response to Issues Paper No. 2,

which dealt with taxation arrangements applicable to these withholding taxes.

While subject to further consideration, the Committee’s provisional view is

that changes to the current withholding tax arrangements are not necessary.

In respect of the business payments withholding tax, further analysis can be

found in Issues Paper No.7 on Microenterprise, Small Business & The Informal

Taxation.

Page 48

CHAPTER 7: TAXATION OF FRINGE BENEFITS

The taxation of fringe benefits provides equity between remuneration that is

received in cash and income which is received as a non-cash benefit. Many

countries include these non-cash benefits in the assessment of an employee’s

income tax liability. PNG follows this approach and includes most fringe

benefits in the assessment of income tax.

However, not all fringe benefits are assessed on the full cash value and certain

benefits may be exempted from taxation or taxed at less than their full value.

For example in PNG, housing and motor vehicle allowances are subject to

specific concessional provisions. This raises the question of whether these

concessions remain appropriate given that the taxable value is

disproportionally low compared to the market value of these benefits.

Of course the provision of fringe benefits has become an integral part of the

overall remuneration offered to employees. This should be taken into account

when considering the package of tax reforms that could be implemented to

lower the rate of personal income tax. In effect the tax treatment of fringe

benefits received by an employee has the effect of lowering the tax paid on the

package of remuneration received.

Housing Allowance

The taxation treatment of housing support to employees will vary depending

on whether the employee is provided an allowance to pay for the item or is

provided the housing directly. Housing supplied to an employee, by his/her

employer, attracts a taxable benefit for income tax purposes as shown in Table

6. These prescribed values are included in the employee’s salary or wages and

taxed at the relevant marginal rate.

Page 49


Table 6: Prescribed values of Employer provided Accommodation

Type of housing Value of taxable benefit per fortnight

Area 1(a)(b)

Area 2 (c) Area 3 (d)

High cost house or flat (e) K700.00 K500.00 K0.00

Medium cost house or flat (f) K400.00 K300.00 K0.00

Low cost house or flat (g) K160.00 K150.00 K0.00

Mess/barrack accommodation K 60.00 K 50.00 K0.00

Government mess/barrack accommodation K 7.00 K 7.00 K0.00

Citizen employees in approved low cost housing scheme

K 0.00 K 0.00 K0.00

(a) Employees provided with accommodation outside PNG by their employer are deemed to reside in Area

1, and are subject to tax on the taxable benefit value for private high cost housing.

(b) Area 1 is any area located in, or within 15 kilometres radius of the boundaries of Goroka, Lae, Madang,

Mount Hagen and Port Moresby.

(c) Area 2 is any area located in, or within 15 kilometres radius of the boundaries of Alotau, Bulolo, Daru,

Kainantu, Kavieng, Kerema, Kimbe, Kiunga, Kokopo, Kundiawa, Lorengau, Mendi, Popondetta, Porgera,

Rabaul, Tabubil, Vanimo, Wabag, Wau, and Wewak.

(d) Area 3 is any place in PNG not included in Area 1 or 2.

(e) High cost housing in relation to employer owned accommodation is any unit of accommodation which

would fetch K800,000 or more if sold on the open market, and in any other case is any unit of

accommodation whose market rental is K3,000 per week or more.

(f) Medium cost housing in relation to employer owned accommodation is any unit of accommodation

which would fetch between K400,000 and K800,000 if sold on the open market and in any other case is any

unit of accommodation whose market rental is K1,000 and K3,000 per week.

(g) Low cost housing in relation to employer owned accommodation is any unit of accommodation which

would fetch K400,000 or less if sold on the open market, and in any other case is any unit of accommodation

whose market rental is K1,000 per week or less.

Housing Allowance paid in lieu of Employer supplied Accommodation

Where an employer pays an employee an allowance in lieu of providing

accommodation, the allowance is assessable in full as part of the employee’s

salary and wages. However, if the employee uses the allowance to rent or

purchase a house then a variation can be obtained from the IRC Commissioner

General. The effect of this variation is to change the tax paid on the allowance

so that instead of the full amount of the allowance being taxed; only a

Page 50

prescribed value of the accommodation and any excess of the allowance over

housing expenditure are taxed.44

Where the housing allowance is less than the actual rent paid, then only the

prescribed value of the accommodation is included in the employee’s salary or

wages and taxed accordingly. Further, citizen employees who are in receipt of

housing allowance and are purchasing a home under the IRC approved low

cost housing scheme, are not taxed on the allowance. Nor are they required to

lodge a Housing Allowance Variation form.

Motor Vehicle

Where the vehicle is provided by the employer and the employee has

unrestricted use of the vehicle the following amount is included in the salary

or wage of the employee:

a. with fuel K125.00 per fortnight

b. without fuel K 95.00 per fortnight Where the employee has restricted use, the IRC Commissioner General

determines the values.

Leave Fares

Leave fares are benefits paid to employees to return to their place of origin or

recruitment. Under Section 40AA ITA, leave fares are exempt for one annual

leave fare for each employee and his or her family. Leave fares in addition to

that provided under the exemption described above are taxable unless IRC

Commissioner General is satisfied that the conditions warrant additional leave

fares due to remoteness or hardship. This section also provides a general

exemption for leave fares for people employed in connection with a mining

lease, special mining lease or mining project or prospecting authority granted

under the Mining Act 1992, or a pipeline licence or a petroleum development

licence granted under the Oil and Gas Act 1998.

44 The following example is provided in an IRC fact sheet. An employee receives K2,000 as

housing allowance. He pays K1,800 as rental for accommodation. He lives in Area 2 (Alotau) in a low cost house. He will therefore be taxed on the excess amount over rent paid, i.e. K200 plus the prescribed value of that accommodation which is K150. So K350 will be added to his/her salary or wages income for tax purposes.

Page 51


Discounted Fares provided to Airline Employees

Discounted airfares provided to employees of an airline by the employer are

taxable fringe benefits. The value of the fare to be included in taxable income is

the lesser of 50% of the standard economy fare for each leg for which the

discount is received or the actual value of the discount provided.

Exemptions

The ITA provides for a number of other exemptions from income tax for

benefits provided by an employer:

subsidies to a citizen employee towards the capital cost of purchasing

a residential dwelling under a first home buyer scheme;

repayable45 amounts that have been advanced to a first home owner

for the purpose of purchasing a property used for housing the cost of

which is K400,000 or less; and

allowances or expenses paid to meet the annual fees imposed by a

school or a college for the purpose of educating a student child of an

employee.

Tax Review Committee’s Assessment

The provision of fringe benefits by employers is a key feature of the personal

income tax system. The tax treatment of most benefits provides concessionality

in that only a proportion of the value of the benefit is taxed. This approach is

not consistent with comprehensive income tax design and causes inequalities

between employees who can access benefits and those who cannot. Fringe

benefits are also a means to provide employees with tax relief that as a matter

of tax policy would be better achieved through lower personal income taxes.

Housing allowance in particular raises a number of questions. The value of the

allowance included in an employee’s taxable income may not capture the

value of the benefit. This will be the case if the schedule of housing allowances

shown in Table 6 does not correspond to housing market conditions. A

consequence of the housing allowance not being taxed appropriately is that

45 These advances must be debited against amounts owed on recreation leave, furlough,

superannuation or gratuity entitlements.

Page 52

employees may choose accommodation options to maximise the tax benefit.

For example, an employee may choose a rental property over other

accommodation options. There is also the potential for the current allowance to

discourage home ownership in favour of renting.

There may be some justification for existing housing concessions if the

allowance was required to attract highly mobile labour that might otherwise

not be available. Further, the relationship between providing allowances by

employers for rental accommodation and the disclosure of rental income

discussed in Chapter 10 is also relevant. It seems an unusual outcome if the tax

system on the one hand encourages the demand for rental housing yet on the

other faces integrity risks from the non-disclosure of rental income by

landlords.

The Commission is of the view that the current taxation of allowances for

housing should be reviewed as part of an overall package of taxation reforms.

Question 7.1 – The Committee welcomes stakeholder comments on the

taxation of non-cash benefits including suggestions for changes to the existing

taxation of benefits that would improve the overall fairness and administration

of PNG’s personal income tax system.

Question 7.2 – Do you agree that the taxable value of the housing allowance

should be adjusted to take account of changes in house values and rentals in

PNG?

Page 53


CHAPTER 8: TAXATION OF INVESTMENT INCOME

Overview

Investment income is a term used to describe the returns an individual receives

from the investment of capital. Normally these fall into the categories of

interest, dividends, rent, capital gains and royalties. Under the ITA, investment

income is either taxed as a final withholding (such as dividends) or subject to

personal income tax with credits allowed for any interim withholding tax paid

(e.g. interest). Section 219 of the ITA also provides a credit for income earned

by residents from overseas sources where tax has been paid on that income to

overseas jurisdictions.

Provisional tax applies to the self-employed as well as persons earning

investment income. For those who are self-employed, personal income tax is

paid on the profit earned after allowing deductions from gross income. Unlike

the provisional tax provisions which is applicable to corporate entities and

superannuation trusts, provisional tax does not form part of the assessment

when initially charged. The provisional tax forms part of the assessment when

the income tax return is lodged. At that time overall income is assessed and

the provisional tax charged is allowed as credit against assessed income.

Taxpayers conducting business as a partnership are liable to income tax on

their share of the partnership income through their own tax returns. The

partnership itself is not subject to tax, although it is required to file a tax return.

A partnership is defined to include any association of persons in receipt of

income jointly.46

During the consultation process in respect to the issues papers released, the

Committee received comments on the tax treatment of investment income,

particularly dividend and investment income. These submissions suggested

reducing the rates of withholding tax to improve the competitiveness of PNG

businesses in attracting shareholder support or reducing the tax burden on

interest on the basis that interest rates were already low. Chapter 6 contains the

details on this in the context of tax rebates and credits.

Regarding interest withholding tax, the tax paid is interim and is subject to

final assessment. Therefore, the amount of tax paid on the receipt of interest

46 Source: PWC Tax facts and figures 2009 PNG

Page 54

will depend on the taxpayer’s total taxable income. The amount of interest

paid to the taxpayer will vary according to interest rate conditions. The fact

that current interest rates are low should not be a consideration in deciding

whether IWT should be reduced. In most countries interest received from

monies lent to financial institutions is taxed as part of the personal income of

taxpayers. The Committee therefore is not convinced that any changes to IWT

are required.

On the taxation of dividends it was suggested to the Committee that reducing

the withholding tax to 10 per cent would enhance the competitiveness of PNG

business. However, no evidence was provided showing that the current

arrangements disadvantaged businesses. As discussed earlier in this paper,

the dividend withholding tax is a final tax and the current tax rate of 17 per

cent is comparable to the tax effect of having an imputation system.

Question 8.1 –Do you have any comments on the taxation of investment income?

Page 55


CHAPTER 9: TAXATION OF RETIREMENT BENEFITS

Introduction

Retirement benefits schemes were established in PNG in 1962 for officers of the

public service.47 Compulsory superannuation was introduced in PNG in 1982

and it was not until the near collapse of the National Provident Fund in 2000

that major reforms to the superannuation industry were undertaken. The

result was the Superannuation (General Provisions) Act 2000 being enacted to

regulate the superannuation industry, including the BPNG becoming the

regulator.

Currently there are four (4) licensed superannuation funds with three (3) major

funds being; the National Superannuation Fund, Nambawan Super and

Defence Force Retirement Benefit Fund Board. The contributors to these funds

are from the private and public sectors and employees of the Army

respectively. One estimate of the number of members in the superannuation

system is 570,117.48 The following Chart shows the growth in superannuation

accounts since 2005.

47 Papua and New Guinea Retirement Benefits Act 1960. 48 National Superannuation Fund Limited in its 2013 Annual Report, comments that it had

461,034 contributor accounts of which 173,799 are active contributors. Nambawan

Superannuation Fund Limited in its 2013 Annual Report reported it has 139,075 contributor

accounts of which 105,371 are active, 33,704 inactive and 2,741 Retirement Savings Account

(RSA) participants. Bank of Papua New Guinea submission dated 9th May 2014

Page 56

Chart 8 Membership of Authorised Superannuation Funds

A real challenge for PNG’s retirement income policy is that it is limited by the

reach of savings in the formal sector, which is in contrast to the large role

family and community play in income support. So any discussion on the

taxation of retirement benefits is therefore limited to the mandatory and

voluntary savings in the formal sector. The superannuation system will not

mature until workers who started work in 1982 retire after a full working life

of making compulsory superannuation contributions. Consequently, it can be

argued that the superannuation system is yet to achieve its most important

objective which is to deliver an adequate income in retirement for the

members of the superannuation funds.49

The Committee’s task of considering the current taxation arrangements for

retirement benefits operating in this context and the two (2) pillars of

compulsory and voluntary savings. Nevertheless, the Committee has reviewed

work undertaken elsewhere such as the review of Australia’s Future Tax

System (AFTS).

AFTS suggested the following policy framework for retirement benefits:

retirement benefits should be broad and adequate;

49 BPNG 9 May 2014 p.2.

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

2005 2006 2007 2008 2009 2010 2011 2012 2013

No

. of

me

mb

ers

Page 57


they need to consider the income requirements of individuals and

should not bias inappropriately other saving decisions;

consider investment, inflation and longevity risk;

be simple and approachable; and

be sustainable and detract as little as possible from economic growth.

The Committee recognises that these principles are only the starting point or a

guide and their relevance is constrained by the character of PNG’s economy

and its stage of economic development. Yet these principles are useful in

considering the limited operation of the current retirement benefit

arrangements. They also raise important questions on the relationship between

income support in the formal and informal sectors and the role of taxation in

influencing intergenerational equity.

Taxing of superannuation may involve transfers from one group to another or

from one time to another depending on whom and when tax is levied. For

example, the Government could remove all taxes on superannuation but

would have to fund the revenue short fall. If it borrowed funds to meet that

revenue short fall, future generations would face the repayment bill; a transfer

of the tax burden from the present to the future. That is one outcome.

Alternatively, the Government could recover the lost revenue through general

tax increases. This would have the effect of transferring the burden from the

future generations back to the present.

In the economic literature, the taxation of retirement savings is seen to have

three (3) distinct phases: The contribution of savings; the investment of

accumulated savings and the final disbursement of these savings in retirement.

These phases can be either subject to taxation or be exempt:50

Tax exempt contributions, tax exempt fund earnings and taxed

retirement benefits (EET);

Taxed contributions, tax exempt fund earnings and tax exempt

retirement benefits (TEE);

50 Dilnot A, Johnson P. The taxation of Private Pensions. Institute for Fiscal Studies 1993.

Page 58

Taxed contributions, taxed fund earning and tax exempt retirement

benefits (TTE) and

Tax exempt contributions, taxed fund earnings and taxed retirement

benefits (ETT).

Both EET and TEE approaches to the taxation of superannuation are usually

suggested as the optimal approach as they approximate equality between pre

and post-tax returns of the fund. TEE and EET are also favoured as they

remove the impact of taxation on the earnings of the fund plus they improve

the ability to manage inflation risks. In contrast the ETT and TTE models of

taxation reduce fund returns so that the pool of funds available to support

retirement is reduced. Hence TEE and EET approaches to tax are similar to an

expenditure tax (taxation based on expenditure) whereas ETT and TTE are

closer to comprehensive income taxation (taxation based on the change in

economic income over a defined period).

In the context of the PNG situation the following table summarises the current

tax applicable to the three (3) phases described above.

Table 8: Summary of the Taxation of Retirement Benefits

Contributions Earnings withdrawals

Employee Taxed at marginal

rate (T)

Taxed at 25

per cent (T)

Tax free (E)

Employer Tax free (E) Taxed at 25

per cent (T)

Taxed at varying rates from 2% to 15%

depending on length of time in the fund,

and whether a RSA is used. (T)

As is illustrated in Table 8, PNG approximates the TTE model. One of the

explanations for the adoption of a TTE model in a developed economy is that

for governments there may only be intertemporal transfers between the tax

and transfer (welfare) systems, assuming retirement income support is

provided. The reduced effectiveness of private savings due to the taxation at

accumulation and fund earnings stages results in the Government facing

higher future budget expenditure associated with welfare payments.

But PNG does not have a formal welfare system; therefore the previous

description is less useful. Yet taxation of superannuation has a direct effect on

Page 59


consumption as the taxation of retirement savings in the present is to reduce

the pool of savings available for consumption in the future. This transfers the

future cost of retirement income support onto the individual and their family.

Taxation of Contributions

Employers with fifteen or more employees are required to register with an

authorised superannuation fund (ASF) to make contributions for their

employees and on behalf of the employee. Employers with less than fifteen

employees may voluntarily register and contribute to an ASF. Under the

Superannuation Regulation 2002 the employee is required to make a mandatory

contribution of 6% and the employer a contribution of 8.4% on behalf of the

employee (based on the employee’s pay). Under current legislation, employees

can also withdraw their own contributions for building their first home, for

renovation purposes and for short term unemployment prior to retirement.

The funds withdrawn for housing purposes are repayable.

Non-citizens do not contribute to resident superannuation funds but the

employer can deduct and contribute to offshore superannuation companies.

The superannuation contributions deducted is not an allowable deduction

under the ITA. The Committee agrees with the view of the Bank of Papua New

Guinea in its submission that this arrangement is appropriate.

In addition to mandatory contributions employees can make voluntary

contributions. These can be in the form of salary sacrifice pre-tax contributions

of up to 6.6 per cent of salary or after tax contributions of up to 9 per cent,

which is the maximum allowable. Any voluntary contributions made by an

employee from pre-tax salary are subject to the administrative arrangements

under Section 361 of the ITA. The IRC limits salary sacrifice to ensure an

employee has 60 per cent of the gross salary or wages (less tax) as take home

pay. Thus the actual tax burden on employee contributions is not as heavy as it

may first appear.

Employers can make contributions in addition to mandatory up to combined

total of 15 per cent. Suggestions made to the Committee indicate that this cap

should be lifted to encourage a higher rate of savings. However, the

Committee has no information before it to suggest that the current cap is

discouraging employers from making additional contributions.

Some submissions queried why employee contributions are taxed and whether

this tax should be removed or reduced. One submission argued that the

Page 60

employer’s contribution should be based on the employee’s full salary rather

than on the amount less any salary sacrifice. The challenge associated when

analysing the current taxation of contributions is that the current law provides

for both taxed and untaxed contributions. Consequently the TTE model is not

fully applied, resulting in contributions not being completely taxed and the

payment of benefits not being wholly tax exempt. This adds to the complexity

of the tax system which would not be necessary if contributions were either

fully taxed or fully exempt.

Any change to the current taxation of contributions needs to be considered in

the context of the revenue consequence and the availability within the existing

tax laws for untaxed contributions to be made. Further, any move to exempt

contributions will need transitional rules for existing contributions.

Simplifying the law does not serve a useful purpose if the current

arrangements are merely to be replaced by a more complex transitional

provision.

Question 9.1 – Do you have any comments on the taxation of contributions to superannuation funds?

Question 9.2 – What transitional rules do you think would be required if the mandatory employee contributions of 6 per cent were made tax free?

Adequacy of Contributions

Several submissions made to the Committee commented on the adequacy of

the existing contribution limits. While this is not a matter which the Committee

will make any recommendations on, for the purposes of informed discussion,

the following table shows PNG in comparison to other countries in the region.

Table 9 International Comparisons51

Country compulsory Minimum Contribution rate

per cent of salary

comment

PNG yes 14.6 Voluntary contributions available

up to cap.

51 Information sourced as at 17 June 2015 from Provident fund websites in NZ, Singapore and

Fiji. PNG data provided by BPNG. Australian data from Australian Taxation Office website.

Page 61


Australia yes 9.5 Caps apply to both pre-tax and

after tax contributions

Fiji yes 40 Single fund: Fiji National

Provident Fund.

New

Zealand

no 6 Contributions are only

compulsory if joining kiwi saver.

Singapore yes 36 Age based contribution levels

Comparing PNG’s retirement income arrangements with those of the region it

shows that there are limitations due to the differences in the schemes and

retirement incomes policies. The Committee understands that the level of

voluntary contributions in PNG is low.52 Yet any increase in mandatory

contributions could not be considered without a full understanding of the

capacity of employees to make extra contributions. Indeed, there is scope

within the existing rules for employees and employers to significantly increase

contributions above the minimum compulsory requirements. The limited use

of this opportunity may indicate that contributors currently do not have the

capacity to make additional payments.

Advances to Purchase Homes

Comments were made in submissions to the Committee that fund members

should be able to access a larger proportion of their superannuation savings for

the purpose of purchasing a first home. Fund members who have been

contributing to superannuation for at least 5 years can apply for an advance of

up to the total of the contributions they have personally made to purchase a

home. This amount does not include any employer component or the

accumulated interest on employee and employer contributions.

Extending the advance beyond the employee contributions raises the question

of the purpose of superannuation savings and whether extending the advance

is consistent with that purpose. Generally, the concessional tax environment of

superannuation is justified by reference to the long term nature of these

savings whereby present day consumption is deferred (savings) for future use

(retirement). However in PNG, home ownership is an essential element of

achieving a sustainable level of living both before and after retirement.

52 BPNG 9 May 2014.

Page 62

Therefore there is good rationale for facilitating the use of a portion of

accumulated retirement savings to purchase of a home.

It can be argued, that given the significant financial commitments involved,

there is a natural friction between the use of superannuation to purchase a

home and the provision for income in retirement. Furthermore, most

contributors to superannuation are low and middle income earners who may

have little capacity to save in addition to the mandatory savings provided by

PNG’s superannuation legislation. Therefore superannuation, for most people

is the main form of savings.

Some suggestions were made to the Committee that improving access to

housing could be achieved by extending the housing loan arrangements to

include the accumulated interest on employee contributions, and or a

proportion of the employer’s contribution. There are several concerns

associated with adopting these suggestions. Firstly, including these additional

monies will further erode the effectiveness of superannuation as a retirement

saving vehicle. Secondly, accumulated interest and the employer components

are subject to concessional taxation and therefore their advance would involve

consumption (purchasing a home) using tax deferred money that normally

would be taxed when these funds are withdrawn on retirement. It is for this

reason that the current rules limit the advance to the funds that the employee’s

after tax contributions. Third, the use of tax preferred savings in this way

introduces a distortion between saving for a home through superannuation

and saving for a home outside of the superannuation system.

The Committee appreciates the importance of encouraging home ownership

and is of the view that the current housing advance arrangements facilitate

this. In the circumstances, the current rules appear to be appropriate.

Page 63


Taxation of Superannuation Fund Earnings

Superannuation funds currently pay 25 per cent tax on their earnings, which is

a concession compared to the company tax rate. Superfunds also receive a

dividend rebate. They are also exempt from dividend withholding tax.

Submissions from the industry argued that the existing rate of tax on fund

earnings was too high and that a lower rate of tax would improve earnings for

the benefit of members. The Committee also received submissions

recommending certain investments tax free, such as investments into

preference shares or Government stock and securities with a maturity in excess

of 12 months.

A review of the taxation of superannuation funds in other countries shows that

the earnings of pension and superannuation funds are generally subject to

concessional tax arrangements.53 In that context the current 25 per cent rate of

tax on PNG superannuation funds (compared to the corporate tax rate of 30

per cent) may not appear high. Yet tax is not the only factor that affects

members’ superfund balances, as shown by the near collapse of the National

Provident Fund in 2000.

It is not clear that the current rate of taxation is unnecessarily high given that

the funds do have access to rebates and exemptions that might otherwise

ameliorate the impact of an earnings tax.54 Caution also needs to be exercised

about the suggestion that certain investments be tax free as this may

unintentionally influence investment decisions and risk exposure.

In a budgetary context a reduction in the earning tax will have a revenue

consequence. The current 25 per cent rate collected (K9,683,000 million in

2014). As noted by the BPNG, the size of the superannuation industry is

expected to grow from K8.9 billion in 2013 to K1 trillion by 2034.55

Consequently, revenue from the taxation of fund earnings will have significant

implications for the PNG budget into the future.

53 Pension funds are usually tax exempt or subject to tax rates on earning significantly less than

the corporate tax rate. See: Tax exempt but conscience. Pensions and Investments 28 April 2014.

54 Dividend withholding tax is rebated and funds would be entitled to double tax relief

associated with overseas earnings where applicable. 55 BPNG 9 May 2014.

Page 64

The superannuation system only covers a small percentage of total

employment in PNG and tax reductions on superfund earnings are likely to be

funded by tax increases elsewhere, including an increase in the GST. Such tax

increases would be a transfer from non-savers to savers. As savers are largely

confined to those employed in the formal economy, there are a number of

inter-sectoral and intertemporal issues to consider in any reform of

superannuation taxation:

tax mix switch would see tax increases on consumption in the informal

and formal sectors supporting tax reductions on superannuation

savings in the former sector; and

intergenerational transfers may arise as the tax benefits received by

retirees are funded from general tax revenue levied on the working

population.

These are complex issues, not easily resolved without careful consideration of

the life cycle tax treatment of retirement benefits, coupled with a clear

understanding of the consequences for the Government’s retirement income

policy. Further, the absence of government welfare system makes it difficult to

make the argument that reducing taxation on superannuation fund earnings

will reduce the call on the government’s budgetary resources in the future.

Consequently the Committee is not convinced that reductions in the tax rate on

superfund earnings should be considered at the present time in the absence of

a comprehensive review of PNG’s retirement income policy.

Question 9.3 – What are the consequences on superfunds of current earnings tax?

Taxation of Superfund Withdrawals

The ITA provides for the concessional treatment of the withdrawal of

retirement benefits on cessation of employment or on retirement. Further

information on the taxation of retirement benefits can be found in the

Attachment. The following chart shows the tax that has been paid on

contributions made to superfunds since 2004.

Page 65


Chart 9 Tax on Superannuation Contributions

Source; IRC

Chart 9 indicates the growing revenue associated with the taxation of

retirement benefits on their distribution to retirees. This is a consequence of the

growth of funds as contributors approach retirement age. The Committee

received several submissions arguing that the taxation of retirement benefits

should be reduced or eliminated. The grounds contended included that

employees already face significant tax burdens over their working lives to the

requirement to maximise funds for retirement, or that benefits should be tax

free once a contributor reached the retirement age of 55.

The tax on withdrawing retirement benefits is only applied to the

concessionally taxed contributions (employer contributions and any voluntary

salary sacrifice amounts) and fund earnings on the member’s account. Any

after-tax contributions can be withdrawn tax free. Furthermore, for employees

with at least 15 years of contributions, their concessional amounts are only

taxed at 2 per cent. Withdrawals are thus lightly taxed when coupled with the

exemption from taxation for employer and employee salary sacrifice

contributions.

The taxation of retirement benefits in PNG has some similarities to the

arrangements in other countries in the region. In Australia, superannuation

withdrawals at retirement are subject to a tax free cap (called the low rate cap),

0

2,000,000

4,000,000

6,000,000

8,000,000

10,000,000

12,000,000

14,000,000

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Salary and wages paid on superannuation distribution

S/W taxespaid ( inKina)

Page 66

after which tax applies.56 In New Zealand, the Kiwi saver account provides for

tax free withdrawals at retirement. In Fiji, pensions paid by the Fiji National

Provident Fund are tax free.

The Committee, while acknowledging the points made in submissions, is not

convinced that the current tax treatment of retirement benefits is

inappropriate. Nevertheless, the Committee is open to further comments and

suggestions from stakeholders on this issue. In particular, the Committee is

open to suggestions that would deal with any inequities in the current taxation

provisions that stakeholders believe should be addressed.

Question 9.4 – Do you have any examples of the taxation of retirement benefit withdrawals where there are inequitable outcomes for retirees?

Retirement Savings Accounts

The Committee received several submissions that raised the issue of RSAs. The

taxation of RSAs is governed by the ITA and was introduced by Nambawan

Super and National Superannuation Fund to encourage retirees not to

withdraw all of their contributions upon retirement. Once a person has

reached retirement age (currently 55 years of age) or has at least 25 years of

service they can open a RSA.57

Under the ITA, RSAs are special retirement accounts where interest on the

account is tax free and the savings can be drawn down periodically free of

income tax, providing an income stream in retirement. However, transfer of

contributions to RSA on retirement is not compulsory and the ITA currently

caps the amount of money that can be transferred to RSAs to K250,000. Draw-

down rules limit the rate at which monies can be withdrawn to protect savings

from dissipation. Withdrawals in excess of prescribed limits are taxed at 30 per

cent.58 Where the draw down is the result of the death of the beneficial owner

of the account, the remaining value of the account may be withdrawn tax free.

56 The low rate cap in Australia is $185,000 for the 2014-15 financial year. Thus the first $185,000

of the component of super that has been taxed concessionally is subject to a zero rate of tax. Amounts above the cap are taxed at the rate of 16.5 per cent subject to a ceiling of $1,355,000 (2014-15 FY).

57 Certain employee groups can open an account with 20 years of service, including police and

fire service members. 58 Tax free withdrawal caps of 20 per cent where account balance exceeds K100,000, 30 per cent

where account balance is between K20,000 and K100,000 and 50 per cent for accounts with K20,000 or less.

Page 67


Submissions that raised RSAs commented that more was needed to encourage

their use and to discourage early withdrawals. Submissions also noted that the

30 per cent withdrawal tax on amounts that exceed RSA withdrawal limit was

inconsistent with the general taxation of retirement benefits. The Committee

notes that the withdrawal penalty is significant particularly when compared to

the tax rate of 2 per cent on withdrawals where a retiree has 25 years of

contributions but also agrees some limitation on withdrawals is prudent.

In the Committee’s view, the issues around the use of RSA’s are regulatory

rather than tax specific. There may be issues around the rules concerning

access sums in special circumstances and while the limitations on withdrawals

may discourage the use of RSAs, the Committee supports the policy behind

regulating access to the funds in retirement savings accounts.

Question 9.5 – How can RSAs be made more attractive for retirees as a way to manage their income during their retirement?

Mandatory Pensions

The issue of mandatory pensions was raised in submissions in response to

concerns that retirees were not taking a longer term view of their income needs

during retirement. The Tax Committee recognises this is a major issue for PNG

in the future as the pool of retirement savings grows and more employees

reach retirement age. Not only will these cause problems for retirees, it will

also present challenges for superannuation funds in the management of their

investment portfolio as members withdraw their funds for immediate use.

Developing a policy to facilitate the use of pensions raises questions. First is,

whether there is likely to be an adequate pool of savings of sufficient size to

make the mandated use of pensions sensible for individual retirees. Regulating

access to funds in circumstances where a small income stream results may not

be sensible. The second is whether a retirement income product can be

designed which addresses the limited use of RSA’s including its relevance to

the pattern of savings and expenditure of Papua New Guineans. In the

absence of a government safety net (e.g. welfare system), restricting access to

retirement funds in a form of a pension income might increase the financial

risk faced by retirees and their families. It would also expose retirees to

financial risks because their retirement funds would subsequently be exposed

to ongoing market and other risks.

Page 68

As with the operation of RSAs, the Committee has been noting the comments

about the slow take up of the use of these accounts. Similar challenges would

exist in terms of requiring retirees to have all or a proportion of their

retirement funds allocated to such accounts. Ultimately, whether the law

mandates that retirees place all or a proportion of their funds into a pension

account is a regulatory question.

Question 9.6 – What tax changes could be introduced to encourage the take up of pensions in PNG? What features or aspects should pension accounts have which are not already available in RSAs? How could or should market risks be managed?

Page 69


CHAPTER 10: OTHER ISSUES

Residency

Residence is an international tax law concept used to tax the legal and natural

persons of a country on their foreign source income. Without this, a country

would only be able to tax these persons on their domestic source income.

Consequently, only resident taxpayers tend to be taxed on their worldwide

income whereas non-resident taxpayers are generally only taxed on their

domestic source income. All countries have residence tests for both natural

persons (individuals) and legal persons (companies). These tests can be based

on legal form and/or economic substance.

The tax residence of individuals is usually based on either a physical presence

in the country (the legal form of which is, such as citizenship); facts and

circumstances that prove residence in a country (economic substance, such as

the country where the person has a fiscal presence); or a combination of the

two. In many cases, this may be satisfied simply by being present in a country

for a set period of time, such as 183 days.

Under Section 4 of the ITA, a resident (or resident of Papua New Guinea) in

relation to a person is defined as:

Whose domicile is in Papua New Guinea, unless the Commissioner

General is satisfied that his permanent place of abode is outside Papua

New Guinea;

Who has actually been in Papua New Guinea, continuously or

intermittently, during more than one half of the year of income, unless

the Commissioner General is satisfied that the usual place of abode is

outside Papua New Guinea, and that he/she does not intend to take up

residence in Papua New Guinea; or

Who is a contributor to a prescribed superannuation fund or who is a

spouse, or a child under 16 years of age, of that contributor.

An alternative to this definition that would be simpler to administer and less

open to dispute would be to define residence using the tax treaty rule. That

rule requires presence in PNG for more than 183 days in any 12 month period

for residency for tax purposes to be triggered.

Page 70

Question 10.1 – Should the definition of residence for tax purposes be revised?

Are there any issues associated with using the 183 day rule as discussed

above?

Taxation of Rental Income

Rental income paid to an individual is taxable under PIT arrangements.

Individual taxpayers who own rental property are required to disclose rental

income and deduct relevant expenses in their income tax return. However,

there are significant concerns that many landlords leasing out their commercial

and residential properties are not declaring rental income to the IRC. The

Committee is also concerned at the continuing lack of redress of this problem

by the IRC.

In the 2015 PNG National Budget, changes were made in the Stamp Duties Act

1952 in response to these concerns. The amendments make it mandatory for

landlords to provide a Taxation Identification Number (TIN) on lease

documents so that IRC can match the stamp duty lease information with IRC’s

lodgement and assessment information to enable improved identification of

non-compliant taxpayers. This measure was effected 1 January 2015.59

It should be noted that some other countries impose a withholding tax on

tenants as a way to address this problem.

59 2015 National Budget,Vol.1 Economic and Development Policies

Page 71


Example: Afghanistan

In Afghanistan, a rental withholding tax is levied at the rate of 10% and

collected by the tenant instead of the landlord and this is remitted to the

revenue authority. This rental withholding is a non-final tax which the

landlord lodges an income tax return claiming expenses incurred in deriving

the rental income and the rental withheld allowed as a credit. The rental

withholding rate when introduced was 20 per cent, but later reduced to 10 per

cent.

The withholding tax is targeted at high-value rental properties only where the

rent exceeds a minimum threshold. Furthermore only entities (such as

companies and organizations) or natural persons using the rented property for

business purposes are liable to withhold. In Afghanistan, tenants who are

exempt from income tax such as aid organisations, NGOs, churches etc.

withhold and remit the tax. There are specific rules dealing with valuing rents

between family members, rents paid in kind, and rents paid in a foreign

currency. Where rental payments are not subject to withholding, the income is

still taxed under the general income tax rules.

It is difficult to make a cross-country comparison, but in Afghanistan the

collections can be significant – up to USD35 million annually (around 2 percent

of tax collections). In addition this has the potential benefits of bringing more

taxpayers and activities into the tax system more broadly.

This general approach was discussed with representatives of the PNG Real

Estate Industry Association. Some of the issues raised were: (a) placing

withholding obligation on tenants has its own risks where tenants are not

paying their own debts; (b) problems for landlords who have other expenses −

where landlords were due refunds, and for which the IRC would need to

refund quickly; (c) the withholding rate must reflect the profitability of the

investment.

Any changes to the law would only focus only on the high-end rental market.

One issue might be that landlords who are not currently paying tax could pass

on the withholding tax to tenants by way of charging higher rent, which in

turn might make tenants reluctant to withhold. There is also the question of

whether tenants withholding would be reliable remitters.

Question 10.2 – Withholding tax regimes need careful analysis, taking into

account PNG circumstances. In particular, are the incentives for tenants to

Page 72

comply with these rules greater than those of landlords to comply with the

existing rules including potential TIN matching?

Question 10.3 – What would be the issues associated with developing a rate

that would collect a suitable amount of tax while limiting the need for the

extensive issue of refunds?

Collection of Tax on behalf of Employees by Businesses

Under Division 2A, sections 299A – 299Q of the ITA deals with collection and

recovery of salary or wages tax. Any employer employing more than one

person is required to be registered as a group employer. The employer is

required to deduct the tax fortnightly from each employee and do so not later

than the 7th day of each month and remit to IRC the total amount of deductions

made in the preceding month. The fortnightly tax deducted is a final tax and

therefore considered to be self-assessment as the deduction of the tax is

deemed to be an assessment of tax due and payable on the salary or wages

earned.

Salary or wage earners who earn other income in excess of K100 are required

to lodge an income tax return for assessment by IRC. The return is required to

be lodged by 28 February after the close of the financial year, unless approval

has been granted by IRC to lodge the return at a later date. Upon assessment a

notice of assessment is issued after taking into consideration IWT, business

payments and royalty tax deducted including provisional tax charged. If the

assessment issued is a debit assessment the amount due must be paid with

thirty (30) days from the date of issue of the notice of assessment.

Question 10.4 – Are there any issues on the taxation of income or benefits that

this chapter has not covered? If yes, what are they?

Page 73


ABBREVIATIONS

AFTS Australia’s Future Tax System review

ASF Authorised superannuation fund

BPNG Bank of Papua New Guinea

CIT Corporate Income Tax

DTA Double Taxation Agreement

DWT Dividend Withholding Tax

GDP Gross Domestic Product

GST Goods and Services Tax

IRC Internal Revenue Commission

ITA Income Tax Act 1959

IWT Interest Withholding Tax

K Kina

LNG Liquid Natural Gas

MTR Marginal Tax Rates

NGO Non-Governmental Organisation

NSO National Statistics Office

NRI National Research Institute

PIT Personal Income Tax

PNG Papua New Guinea

RSA Retirement Savings Account

SME Small and Medium Enterprise

TIN Taxpayer Identification Number

Page 74

REFERENCES

Australia’s Future Tax System: Retirement Income Strategic Issues Paper.

Australian Treasury 12 May 2009

Australian Taxation Office termination payments

https://www.ato.gov.au/printfriendly.aspx?url=/individuals/working/in-

detail/leaving-a-job/Taxation-of-termination-payments/#Invalidity_formula

Bird, R and Zolt, E. Redistribution via taxation: the limited role of the personal

income tax in developing countries. 2005,

http://www.researchgate.net/publication/4905326_Redistribution_via_Taxation

_The_Limited_Role_of_the_Personal_Income_Tax_in_Developing_Countries

Dilnot A, Johnson P. The taxation of Private Pensions. Institute for Fiscal

Studies 1993

Hendy, P Warburton, D. International Comparisons of Australia’s taxes 2006

http://comparativetaxation.treasury.gov.au/content/report/html/12_Chapter_10

-03.asp

Holzmann, R Pouget, Y Vodopivec, and Weber, M. Severance Pay Programs

around the World: History, Rationale, Status and Reforms. World Bank May

2011.

Keen, M. Taxation and Development - Again. IMF Working Paper 2012

National Budget 2015,Vol.1 Economic and Development Policies

National Statistical Office 2009 – 2010 Papua New Guinea Household Income and Expenditure Survey

OECD 2006, Fundamental Reform of Personal Income Tax No.13.

Peter, Klara Sabirianova Buttrick, Steve and Duncan, Denvil. ‚Global Reform

of Personal Income Taxation, 1981-2005: Evidence from 189 countries‛,

National Tax Journal. 2010 Vol. 63, pp. 447–78.

Piatti M, Schaffner M, Torgler B. Increasing Tax Compliance in Papua New

Guinea. The National Research Institute 29-30 May 2014.



http://comparativetaxation.treasury.gov.au/content/report/html/12_Chapter_10-03.asp

http://comparativetaxation.treasury.gov.au/content/report/html/12_Chapter_10-03.asp

Page 75


PWC Tax facts and figures 2009 PNG

World Bank Country Partnership for the Independent State of PNG for the FY

2013-2016, World Bank 8 November 2012.

World Bank. Tax revenue as a percentage of GDP http://data.worldbank.org/indicator/GC.TAX.TOTL.GD.ZS

http://data.worldbank.org/indicator/GC.TAX.TOTL.GD.ZS

Page 76

ATTACHMENT: THE TAXATION OF PERSONAL

INCOME AND EMPLOYEE BENEFITS

Income tax is imposed on assessable income derived by all PNG residents. The

financial year is a calendar year commencing 1 January and ending 31

December. The tax applies to worldwide income while non- residents are

taxed only on their PNG sourced income. If foreign source income has been

taxed by the other jurisdiction, the Income Tax Act 1959 (ITA) allows resident

taxpayers to claim a credit against the tax assessed as payable on their

worldwide income.

Residence

Under Section 4 of the ITA, a resident (or resident of Papua New Guinea) in

relation to a person is defined as:

Whose domicile is in Papua New Guinea, unless the Commissioner

General is satisfied that his / her permanent place of abode is outside

Papua New Guinea;

Who has actually been in Papua New Guinea, continuously or

intermittently, during more than one half of the year of income, unless

the Commissioner is satisfied that the usual place of abode is outside

Papua New Guinea, and that he/she does not intend to take up

residence in Papua New Guinea; or

Who is a contributor to a prescribed superannuation fund or who is a

spouse, or a child under 16 years of age, of such a contributor.

Non-resident is a person who does not satisfy the requirements of Section 4. A

non-resident does not have access to the tax free threshold and other tax

concessions or benefits may be available.

Personal Income Tax Rates

Table 1 in Chapter 1 described the separate marginal tax rates for resident and

non-residents. The PIT has 6 income bands and associated marginal tax rates.

Page 77


Residents are also able to access a tax free threshold of K10,000. Marginal tax

rates start at 22 per cent with a top marginal tax rate of 42 per cent.

Withholding Tax

As described in Chapter 1 withholding taxes are applied to payments of

dividends, interest and royalties. Withholding tax is also applicable to

management fees and payments to foreign contractors.

Superannuation Benefits

Companies employing at least 15 persons must provide employee

superannuation. Employee contributions are deducted from after-tax salary at

a minimum rate of 6 per cent, while the employer deducts a minimum of 8.4

per cent (and maximum of 15 per cent) of the employees’ gross salary. This

payment of superannuation by the employer is exempt from income tax.

Distributions from superannuation funds are subject to tax rates from 2 per

cent to the taxpayer’s marginal tax rate, depending on years of service and

whether any of the amounts related to pre 1993 amounts. The following tables

summarise the tax on superannuation contributions and the tax on

superannuation withdrawals.

Table 3: Taxation of Superannuation Taxation

Contributions Earnings in fund withdrawals

Employee Taxed at marginal

rate

Taxed at 25 per

cent

Tax free

Employer Tax free Taxed at 25 per

cent

Taxed at varying

rates from 2% to

marginal tax rate.

The taxation of superannuation withdrawals is described in the following

table.

Page 78

Table 4: Taxation of Superannuation Withdrawals

Years of Contributions

Less than 5 years

Not less than 5 years and not greater than 9 years

Not less than 9 years and not greater than 15 years

More than 15 years

Rate of tax Marginal rate

The lesser of 15% or the marginal rate

The lesser of 8% or the marginal rate

2% of any pre 1993 amounts

The 2 per cent tax rate for withdrawals is also available for employees where

the employer contributions have been made for not less than 7 years and the

employee is 50 years of age or older, or where they have been subject to

enforced early retirement.

Employees leaving a superannuation fund can also voluntarily transfer up to

K250,000 to a RSA which provide a tax free environment for drawdowns

provided the following conditions are met.

Table 5 RSA Withdrawal Limits

Fund size Less than

K10,000

K10,000-

K20,000

K20,000-

K100,000

K100,000-

K250,000

Access

limits

50% of funds

in the first

year

50% of funds

in any one

year

30% of funds

in any one

year

20% of funds

in any one

year.

Chapter 10 provides further information on the taxation of retirement income.

Taxation of Fringe Benefits

All allowances provided to employees are liable for taxation. However, certain

benefits are exempted from taxation or are taxed at less than their full value.

For example, housing and motor vehicle allowances – these are subject to

specific concessional provisions. Chapter 7 gives a description of the fringe

benefits that are subject to tax.

Salary Structuring

Page 79


Salary structuring is permitted under Section 361 of the ITA as long as it is not

an arrangement to avoid payment of salary or wages tax. Under this legislation

IRC has administratively allowed a 60:40 split to ensure an employee has 60

per cent of the gross salary or wages (less tax) as take home pay.

The 40 per cent portion of the gross salary can be structured for leave fares,

motor vehicle, school fees, housing, superannuation and must be included in a

contract of employment, payslip and statement of earnings so that it can be

easily identified by the employee and IRC. Strict administrative conditions

apply on the method of payment. Non adherence will result in the employee

liable to tax on the full amount without regard to the exempt amounts and the

employer liable to a fine not less than K5,000 and more than K50,000. The

Committee is concerned about the fact that even 60% ‚take home‛ pay is in

this day and age is not enough hence the strong desire from

submissions/public consultations about employees saving culture or lack

thereof and the effects on living standards of hundreds and thousands of

ordinary PNGeans.

Losses

Losses can be carried forward for 20 years but cannot be carried backward, to

offset against income in previous years. Losses from overseas investments can

only be offset against overseas source income. Losses from primary industry

can be carried forward indefinitely.

Termination Payments

Under Section 46CA of ITA a concessional rate of 15 per cent applies to

redundancy payment under an approved private sector redundancy scheme.

The concessional component is the lesser of base salary plus (service amount

times years of service) or K50,000.

For the public servants, a termination payment under the Rationalisation of the

Public Service (Budget Provisions) Act 1995 paid on or after 1 January 2012 is also

subject to concessional rate of tax, however this has lapsed.

Ex Gratia Payments

Page 80

These are payments the employer makes that are separate to specific

entitlements such as annual leave or long service leave.60 These are payments

that are additional to what may be expected in the case where an employee

leaves a company voluntarily or is dismissed due to misconduct. Ex gratia

payments are taxed at the taxpayer’s marginal tax rate unless they fall within

the concessional arrangements provided under a redundancy scheme

approved under Section 46CA of ITA. Ex gratia payments made under this

provision are taxed at 15 per cent up to a cap of K50,000.61

Unpaid Annual Leave and Long Service Leave

Annual leave and long service leave are not included as redundancy payments

under the concessional arrangements which are applied to approved

redundancies. Pay outs of annual leave and long service leave are taxed at

taxpayer’s marginal tax rate. However, any proportion of long service leave

that has accrued prior to 1993 is taxed at 2 per cent.62

Capital Payment for Personal Injury

These are taxed separately and not subject to the concessional rates applicable

to termination payments.

Loans, Dividends, Employee Share Scheme Payments and constraint of

Trade Payments

These payments cannot be included in the amounts subject to concessional tax

treatment. They are taxed at the employee’s marginal tax rate.

Business Payments Tax

According to Section 280 (9)(a) business payments withholding tax is deducted

at the rate of 10 per cent on business income or eligible payments. The

withholding tax is not final and the payee is required to lodge an income tax

60 For example non transferrable sick leave may be paid out as an ex gratia payment on being

made redundant to help relieve hardship. 61 The legislation specifies certain conditions for the concessional rate to apply. The taxpayer

must be a resident, have at least 5 years of unbroken service, not be in retirement, have not received a redundancy payment previously from the same employer, or not be older than 65 years of age. The concessional amount is calculated using a base amount (currently K5,000) and an amount per year (currently K2,000).

62 For employees who have pre 1/1/1993 long service leave are subject to a cap of 6 weeks and a

minimum of 6 years‟ service.

Page 81


return for the income to be assessed and the business payments tax deducted

allowed as a credit against the gross tax assessed.

Documents

Papua New Guinea Taxation Review (2013-2015)taxreview.gov.pg/wp-content/uploads/2015/08/15.08... · Papua New Guinea Taxation Review (2013-2015) Issues Paper No.8: Personal & Retirement