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Attribution vs Market Salary rules

McIsaacs Ltd • Oct 20, 2022

The introduction of the 39% tax rate for individuals who earn over $180,000 from 1 April 2021 has reignited Inland Revenue’s interest in the income attribution and market salary regimes. These rules currently prevent a person from having income earnt from individual efforts or “personal services” taxed through an associated entity at a lower tax rate. With an 11% difference between the top individual tax rate and the NZ company tax rate, the application of these rules is likely to be closely scrutinised in upcoming years.


The attribution rules will generally apply when a taxpayer who earns income of more than $70,000 from personal services inserts an associated entity between themselves and the party acquiring their services. These rules do not strictly apply if the associated entity derives income from numerous, unrelated parties, provided one party does not make up 80% or more of the entity’s income.


For example, compare the two scenarios:


1.    Paul contracts Sarah Limited for $200,000 – all the services are performed by Sarah, and Paul is Sarah Limited’s only client.


2.    Four non-associated individuals: Paul, Eugene, Rebecca and John, each contract Sarah Limited for $50,000 each – all the services are performed by Sarah.


The income attribution rules would only apply to scenario 1 above, forcing Sarah to return all of Sarah Limited’s net income in her personal tax return.

However, in the second scenario, although the income attribution rules do not apply, the market salary principles still need to be considered to determine the amount of income to return in Sarah’s personal tax return.


The Supreme Court established the leading precedent in the case of Penny & Hooper v Commissioner of Inland Revenue (2009) that a failure to pay a “commercially realistic salary” for services rendered is an important consideration in determining whether an arrangement amounts to tax avoidance.


Revenue Alert 21/01, released on 29 March 2021 ahead of the increase in the top marginal tax rate, also provides further guidance, and states that Inland Revenue is more likely to examine arrangements where the salary paid from an entity to an associated working individual is less than 80% of the entity’s net income. While this is not a legislated de minimis rule, it suggests it is unlikely Inland Revenue will challenge the amount of an individual’s salary if the 80% threshold is met. On the other hand, not meeting the threshold should not automatically amount to tax avoidance.

Both the attribution and market salary regimes should be kept in mind when determining salary levels. People don’t often appreciate that there is both a specific set of income attribution provisions to consider and a separate market salary principle as per ‘Penny & Hooper’.

22 Mar, 2024
As we draw close to the end of another financial year, to assist you with your end of year close off we have provided a list of things to do before 31 March , on 31 March , and soon after 31 March . Before 31 March 2024 Bad Debts Please review your Debtors Ledger for any bad debts. To claim a deduction for bad debts, the defaulting accounts MUST be written off your Debtors Ledger prior to the 31st of March 2024. It is not enough to actually reduce the amount of the debtors after balance date by the amount of estimated bad debts or unrecoverable amounts owing. In most accounting systems this means creating a credit note to the defaulting debtors account and coding it to the account code Bad Debts. If the original invoice included GST, then you can claim GST on the credit note. Fixed Assets Review the fixed asset register for items that have either been sold or scrapped during the year. The Fixed Asset schedule can be found in your previous years Financial Statements. If you need another copy, contact our office for a copy. Please ensure you have narrated the entries coded to fixed assets with enough information for us to determine what has been purchased and have copies of invoices and any related financing readily available for us. Repairs & Maintenance It's a good time to review what you have coded to fixed assets and repairs and maintenance. All assets costing less than $1,000 (excl GST) may be claimed as an expense in the year of purchase, amounts greater than $1,000 (excl GST) could potentially be fixed assets. Please ensure you narrate these well in your accounting system for us to reduce queries on the job. Structures & Financing It may be time to consider an alternative structure or financing method for your business. Now is the time to consider Companies, LTC's and Trusts. If you are interested please contact us. Dividends It may be appropriate to declare a dividend on or before 31 March. This may require top up income tax to be paid by 31 March 2024. On 31 March 2024 Trading Stock Your stock (including work in progress) must be counted, recorded and valued at 31 March 2024. The trading stock rules require that you value at the lower of cost, net realisable value or market selling value. Remember to exclude GST from your calculations and prepare a written record of your stocktake. Stock value less than $10,000 - if your total gross income for the year is $1.3 million or less; and - you can reasonably estimate your stock on hand at 31 March 2024 to be less than $10,000 (excl GST), you can choose not to value your closing stock or to include any change in value. Holiday Pay & Wage Reports Some payroll software systems do not allow for printing reports subsequent to 31st March, so ensure you have the reports printed as close to the end of the month as practical. This is particularly important for clients who accrue holiday pay outstanding at balance date. Shortly after 31 March 2024 Year End Bank Reconciliations If you have a computerised cashbook (Xero, MYOB etc.) , when you receive your bank statement for 31 March 2024, ensure all transactions are entered for the year, perform a bank reconciliation to this date being 31 March 2024 and print a hard copy for your records. PAYE Payments Due 5 th /20 th April 2024 If you intend to pay out Directors Fees or additional bonus / top up salaries to either your employees or shareholder employees, you will need to pay to the IRD the PAYE content of the payments by the 5 th or 20 th of April 2024. Dividend RWT Payments Due 20th April 2024 If you intend to declare dividends on 31 March 2024 you will need to pay relative RWT content by 20 April 2024. Interest RWT Payments Due 20th April 2024 If you intend to pay interest on loan accounts at 31 March 2024 you will need to pay to the IRD the RWT content of the interest by 20 April 2024. 3rd Provisional Tax Instalment Due 7th May 2024 (for 31 March balance dates) The final instalment of 2024 Provisional tax is not due till after the end of the year. While this may be good for cash-flow, it could have negative implications if you want to pay a dividend this year. If you think this affects you, and you would like us to review your imputation credit account or have any concerns, please contact us. PREPARATION OF YOUR 2024 ANNUAL FINANCIAL STATEMENTS & INCOME TAX RETURNS Our Client Annual Checklists are available on our website at www.mcisaacs.co.nz under the "Financial Resources" tab, "Client Annual Checklists". To simplify these checklists we have separated them out into the type of entity and provided specific ones if you have a rental property or mixed use assets. 2024 Business Checklist 2024 Personal Checklist 2024 Rental Checklist 2024 Mixed Use Holiday Home, Boat and Plane Checklist These need to be completed and signed before we process your 2024 information. The accuracy and completeness of this information you provide has a direct influence on the time required to perform your assignment. When you have compiled your financial records for us please remember to include the completed and signed Checklist(s). If you do not have access to our website and require a copy of the Checklists, please give us a call and we can email a pdf of them to you or we will post them to you, whichever you prefer.
22 Mar, 2024
Our Client Annual Checklists are available on our website at www.mcisaacs.co.nz under the "Financial Resources" tab, "Client Annual Checklists". To simplify these checklists we have separated them out into the type of entity and provided specific ones if you have a rental property or mixed use assets. 2024 Business Checklist 2024 Personal Checklist 2024 Rental Checklist 2024 Mixed Use Holiday Home, Boat and Plane Checklist These need to be completed and signed before we process your 2024 information. The accuracy and completeness of this information you provide has a direct influence on the time required to perform your assignment. When you have compiled your financial records for us please remember to include the completed and signed Checklist(s). If you do not have access to our website and require a copy of the Checklists, please give us a call and we can email a pdf of them to you or we will post them to you, whichever you prefer.
22 Mar, 2024
Sitting back at your desk after a month of busy family time or relaxing beach days, business owners and executive teams should start to think about not only the year ahead, but the long-term viability of their businesses. With rapid changes and multiple existential threats impacting different businesses in different ways, it might be an opportune time to ask yourself: Do you expect your market and/or customers to be subject to fundamental change? Will your business be viable in ten years’ time if it continues on its current trajectory? Do you have the option of carrying on as you are and hoping for the best, or do you need to make some proactive (and potentially risky) changes to give your business the best chance of continuing into the future? With pressure from consumers for reinvention intensifying, it’s no surprise that we are seeing businesses adopting new technology. Air New Zealand, aware of its reliance on fossil fuels, is looking at new ways to power their aircraft fleet. They have just purchased their first all-electric aircraft which will operate cargo routes starting in 2026. They also plan to begin replacing their regional domestic fleet with more sustainable aircraft, with goals to use either green hydrogen or battery hybrid systems from 2030. Other companies are pivoting into new areas to meet changing consumer demands. For example, consider the amount of ‘plant-based alternatives’ available today, with fast food restaurants like Burger King offering an entire range of plant-based meat. It's no secret that climate change and sustainability are hot topics at the moment, and while much of the change is driven by Government, the reality is that consumers are forcing these changes with their wallet. It is becoming more and more common for a business to accept a lower return on climate-friendly investments, showing a willingness to accept a trade-off of financial return for sustainability outcomes. Electric vehicle sales are rising across the country, and while it might not have been a consideration 20 years ago, consumers now consider whether the products they purchase have been ethically and sustainably produced. Companies even need to be mindful of sustainability if they want access to capital, with banks, investors and equity funds refusing to invest or adopting a sinking lid approach depending on the industry a company operates in. The changes happening now are not just something that the big companies need to worry about. Small companies are more likely than their larger company counterparts to feel their company’s viability threatened, and for good reason. The shifts over the coming decades will have flow on effects to all facets of business. Think electric cars – what is a mechanic doing 20 years from now, or a petrol station operator, or the person that leases the land to the petrol station? By taking the time to reflect, you place yourself in a much better position to not only survive the next few decades but also capitalise.
22 Mar, 2024
The concept of what is a “dividend” is very broad and starts with the default proposition that any transfer of value from a company to a shareholder is a dividend. That concept includes the simple scenario of an interest free loan to a shareholder or a person associated to a shareholder; which can also include loans between companies. This matters because a dividend is taxable to the recipient, but not deductible to the payer, i.e. it gives rise to a net tax cost. The standard solution to eliminate the dividend is to charge interest on the loan at either a market rate or the prescribed FBT rate (depending on the parties to the loan). But not all interest free loans made by a company will give rise to a deemed dividend, some do, some don’t and this is an area where mistakes are often made resulting in either no interest being charged when required, or interest being charged when it is not required. When determining whether loans between related companies can be interest-free or not, two key sections of the Act should be considered – sections CD 27 and CW 10. If section CD 27 applies, a transfer of value is specifically excluded from being a dividend and then can be ignored for this purpose. The section applies to ‘downstream’ dividends, e.g. a loan from a parent company to a subsidiary. The provision itself is complex and needs to be worked through on a case by case basis, but it is helpful. If the exemptions in section CD 27 do not apply and a dividend has arisen, then section CW 10 may help. The section is a broader provision that deems a dividend between wholly owned companies (i.e. companies that have identical shareholders) to be exempt income of the recipient. This is an area Inland Revenue has and will continue to scrutinize, as seen in a recent Technical Decision Summary (TDS), TDS 24/01. The TDS concerned an interest-free loan made from a parent company (Company C) to a subsidiary (Company A) and whether the interest-free loan gave rise to a dividend to Company C (yes, the lender). Importantly, the Tax Counsel Office (TCO) initially points out that Company A is the recipient of the value (being the interest-free loan), hence no dividend has arisen to Company C. The TCO then concluded that the exclusion under section CD 27 applied such that the interest-free loan did not give rise to a dividend. The TDS also commented on whether the arrangement comprised ‘tax avoidance’ and stated that it did not raise any tax avoidance concerns because the legislation was working as intended because the Act contemplated capital could be provided by way of interest free loan. Reading between the lines, it appears an over eager person at Inland Revenue was trying to find something that wasn’t there. As an aside, trusts legally do not pay dividends, hence the deemed dividend risk and therefore the need to charge interest (from a tax perspective) should not apply to a trust
22 Mar, 2024
The Working for Families Tax Credit (WFFTC) is a notoriously complex scheme when it comes to determining eligibility and quantifying entitlement. This leads you to wonder how well the scheme is policed by Inland Revenue, and whether fraud is able to ‘fly under the radar’. Accordingly, it was heartening to see a case brought before the Taxation Review Authority in October of last year regarding a taxpayer making false claims about their de facto relationship. The taxpayer claimed $39,740 of WFFTC’s for the years 2015 to 2018 on the basis that they were a single parent. However, at the time they were living with a Mr X, with whom the Commissioner considered the taxpayer to be in a de facto relationship. Support was given by the taxpayer, their sister, and Mr X claiming that no de facto relationship existed. However, the evidence to the contrary was extensive. They lived together, went on holidays together, had social media profiles that indicated they were a couple, attended work functions as a ‘couple’ and were financially interdependent. As a result, the income of Mr X was deemed to be included in the WFFTC calculation and the taxpayer’s actual entitlement for the four years was reduced to nil. If the taxpayer was not satisfied with this, the Commissioner went further to say that regardless of whether a de facto relationship existed or not, their entitlement would have been reduced anyway due to the taxpayer stealing from her place of employment. Because they had stolen money, it would count as income towards the calculation of their WFFTC and their entitlements should have been reduced in 2016 and 2018, and no entitlement would have existed in 2017. The taxpayer claimed that the Commissioner should exercise their discretion to not collect tax given that the stolen money was used to fund their gambling addiction. Unsurprisingly, the Commissioner held that the taxpayer’s circumstances were ‘far from justifying the exercise of such a discretion’. Although this case demonstrates some absurd circumstances, it provides comfort that Inland Revenue does apply resources to ensure schemes such as WFFTC are policed and that their exploitation is met with appropriate action. It also demonstrates the variety of investigation skills within Inland Revenue and provides a warning for those who are considering stretching the truth when it comes to their WFFTC claims.
22 Mar, 2024
You would have seen a lot of this in the news recently about these changes, so we thought a brief summary would be useful. If you have any queries about how these changes might impact you, please contact us and we can help evaluate your situation. Interest Deductibility The ability to claim interest deductions will be phased back in with 80% of deductions allowed from 1 April 2024 to 31 March 2025 and 100% allowed from 1 April 2025 onwards. Phasing back in of interest deductibility will be allowed for all taxpayers, whether they acquired the property, or drew down lending, before or after 27 March 2021. Brightline Changes The current 10 year and 5 year new build bright-line tests in section CB6A will be repealed and relaced with a new 2 year bright line test. The main home exclusion in section CB16A will be returned to its original form. The exclusion will apply if the land has been used predominantly ( i.e. more than 50% of the land area), for most of the time the person owned the land (i.e. more than 50% of the period) for a dwelling that was the person's main home. Removal of Depreciation on Commercial Buildings The depreciation rate for all buildings with an estimated useful life of 50 years or more will be set at 0%. The 0% means buildings will remain depreciable property and historical depreciation deductions will remain recoverable when calculating depreciation recovery income. The 0% rate will apply to buildings regardless of when the building was acquired. The estimated useful life is determined on a whole of life rather than remaining life basis. Trust tax rate increase The trust tax rate will increase from 33% to 39% from 1 April 2024. If a trust has net income of $10,000 or less the tax rate will remain 33%. If you have a company with retained earnings with a trust shareholder, you may wish to consider declaring a dividend before 31 March 2024 - please contact us as soon as possible if you think you might be in this situation.
17 Dec, 2023
Christmas is fast approaching and so is the time that businesses may reward customers and staff with Xmas functions and Xmas gifts. This article considers the deductibility of these expenses. Fully Deductible Gifts to clients are 100% deductible, provided they do not come within the Entertainment Rules (below). For example, gifts to clients of movie tickets, books or calendars would be fully deductible. Entertainment Rules The following is a list of the types of entertainment where deductibility is limited to 50%: The cost of corporate boxes, corporate marques or tents The cost of accommodation in a holiday home or time-share apartment The cost of hiring a pleasure craft The cost of food and beverages enjoyed in any of the three locations listed above Food and beverages enjoyed on or off the business premises for a social event GST on these expenses is also limited to 5 0%. So gifts of beer, wine and food to clients will be 50% deductible, as will food and beverages provided at a Xmas social function with clients or staff. However there is an exception where the benefit is provided to an employee and the employee can choose when and where to enjoy the benefit, or the benefit is enjoyed outside of New Zealand. For example, a meal voucher given to an employee would come within the FBT rules rather than the entertainment rules, as the employee can choose when and were to enjoy the meal. FBT Rules Gifts to staff are generally treated as a fringe benefit unless the benefit is covered by the entertainment rules. However, if the value of the gift is less than the FBT exemptions for employees and employers, then FBT will not be payable. These exemptions are: $300 per quarter per employee (if the employer pays FBT quarterly); or $1,200 per annum per employee (if the employer pays FBT on an annual basis); and Total unclassified fringe benefits provided by the employer to all employees is not more than $22,500 per annum
17 Dec, 2023
When the top personal tax rate for individuals increased to 39% from 1 April 2021, it was not surprising to see an increase in the number and quantum of dividends declared by companies (owned by individuals) in the lead up to the change. With the anticipated increase in the Trust tax rate from 33% to 39% from 1 April 2024 next year (for trusts with a 31 March balance date) it is likely a similar increase will occur. Given the expected 6% difference in tax payable it is reasonable to assume Inland Revenue will review any dividend payments it happens to encounter as part of their audit activity. Worst case, Inland Revenue could assert a dividend was not ‘properly’ documented and therefore not legally effective or the process followed meant that it was “derived” by the trust after the 39% rate came into effect. It is therefore important to get the basics right. A company is generally able to attach imputation credits (comprising previous tax paid) to a dividend, and where it is being paid to a trust that does not hold a certificate of exemption from resident withholding tax (RWT), RWT will need to be withheld and paid to Inland Revenue by the 20th of the month following payment. A late payment of RWT would comprise a potential ‘flag’ that a dividend was not properly executed ‘on-time’. Dividends are not always paid in cash. It is common for a company to declare a dividend and credit the amount to its shareholders’ current accounts. The process of journaling the dividend can comprise “payment” as it provides the mechanism or entitlement for a shareholder to extract cash from the company in the future or is often used to clear an ‘overdrawn’ shareholder current account. A potential risk is that if the journalling is completed late, say after 1 April next year, the dividend income could in fact be derived at that time and therefore taxable at 39%. If a dividend is to be paid in cash, it should be paid prior to 1 April 2024. Some may try to argue the date of the dividend resolution is sufficient. However, rather than rely on a ‘view’, paying the cash or entering the journal should put the matter beyond doubt. Care and attention need to be taken, to ensure getting the basics wrong does not cause a problem.
17 Dec, 2023
The Business Payment Practices Act 2023 (‘the Act’) was enacted on 26 July 2023. It will require certain entities (‘reporting entities’) to publicly disclose specific information about their payment practices. Making up over 97% of all businesses in New Zealand, small businesses often do not have the financial resources or market influence to cope with late or long payment times. Payment delays from customers can create significant cashflow problems. The purpose of the Act is to provide greater transparency in business-to-business payments and enable members of the public and other entities to access information about those payment practices, so that they can make informed decisions about who they want to do business with. An entity will be a reporting entity and subject to the disclosure requirements under the Act if, at each of its two preceding accounting periods, it had (together with its subsidiaries): total revenue of more than NZ$33m, and total third party expenditure (excluding salaries and wages) of at least NZ$10m. A reporting entity will be required to make disclosures every six months on a publicly searchable register. The first disclosure period runs from 1 July 2024 – 31 December 2024, with the second disclosure period running from 1 January 2025 – 30 June 2025. However, only reporting entities which had (together with its subsidiaries) total revenue exceeding NZ$100m at each of its two preceding accounting periods are required to disclose from the first disclosure period commencing 1 July 2024. This phased approach provides additional time for smaller reporting entities to transition to the new rules, for example, to change or put in place new processes and systems to be able to comply. Reporting entities will have up to three months after the end of a disclosure period to file their disclosures. The points below summarise the different types of information that will be required to be disclosed by a reporting entity every six months: The average payment time for invoices (from when invoices are received to when paid in full). The percentage of the total number of invoices paid in full within specified day periods. The percentage of the total value of invoices paid in full within specified day periods. Whether the reporting entity allows other entities to use e-Invoicing. Whether the reporting entity uses standard payment terms and what those terms are. There are a number of exclusions (i.e. information not required to be disclosed) from the disclosed information for items such as: salary/wages, tax, rent or lease, utilities charges, transactions not in NZD and intra-group transactions. Penalties will apply for non-compliance, including up to $9,000 for failing to make a disclosure, and up to $50,000 for an individual or $500,000 for an entity for filing false or misleading information. If your business meets the definition of a reporting entity, it is time to start considering what internal processes will need to be implemented to ensure compliance with the Act. For small businesses, it won’t be too long before you’ll be able to search the payment performance of some of your suppliers.
17 Dec, 2023
Given the necessity of providing fast relief, the wage subsidy scheme provided during COVID in NZ was largely based on trust. Today, MSD operates a Wage Subsidy Integrity and Fraud Programme aimed at ensuring the integrity of the payments and who received them. So far, 38 people have been brought before the courts in relation to wage subsidy misuse, 37 businesses have civil recovery action underway to recover payments and 11 cases of significant and complex alleged wage subsidy fraud have been referred to the Serious Fraud Office. By and large, businesses in NZ were sincere in their wage subsidy claims, but overseas there are some more extreme examples where this was not the case. Each year, the Association of Certified Fraud Examiners selects the five most scandalous fraud stories of the year. One of those stories was the arrest of 47 people affiliated with a Minnesota based non-profit ‘Feeding our Future’, which defrauded USD$250 million in COVID relief funds through claiming to feed children during the pandemic. The elaborate scheme used various fake documents, invoices and shell companies to give the appearance of providing meals to children, while using the money to purchase luxury cars, jewellery and coastal property abroad.
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