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Beware of paying excessive salaries

It is very common for family owned companies to employ members of the family in the business on a permanent or casual basis. There is no problem with this per se, however income tax rules seek to prevent 'excessive salaries' being paid to family members.

Inland Revenue has recently been focusing on this issue and has been scrutinising the type of work completed, the amount paid, the way in which it was calculated, and what a third party might be paid for the same work.

There is no precise measurement as to what constitutes 'excessive', as each case is different. What is most important is that business owners determine the value of a relatives remuneration based on the service provided to the business. The relative should be paid the same amount as an unrelated employee performing similar duties.

IR has the ability to intervene and reallocate remuneration, income or losses if it considers the amount is not reflective of the value contributed. If an amount is deemed to be excessive, the excess may be recharacterised as a dividend and therefore non-deductible to the payer. Where salaries to family members are paid it is important to ensure the employment and the amount paid is calculated and documented on an arms-length basis.