Fair market salary reminder
There is a general need for a business to pay associated employees a fair market salary for their personal service. Given the implementation of a 39 percent personal marginal income tax rate on income over $180,000 from 1 April 2021, Inland Revenue’s scrutiny of such salaries is expected to increase. This has been confirmed through IR issuing two related documents in March 2021 in quick succession, namely:
- Interpretation Statement 21/02 – Income tax – Calculating income from personal services to be attributed to the working person (released 19 March 2021); and
- Revenue Alert 21/01 – Diverting personal services income by structuring revenue earning activities through a related entity such as a trading trust or a company: the circumstances when Inland Revenue will consider this arrangement is tax avoidance (released 29 March 2021).
Both of these are aimed at warning taxpayers against the use of associated entities or family members, to avoid the highest personal income tax rate on income from the supply of services that they personally perform. For example, surgeons or consultants operating through a company.
We have seen instances where the same flat salary amount is allocated annually to working shareholders for numerous years, without an annual review of that salary nor a comparison to market.
It is a timely reminder to review salaries paid to associated employees to ensure they reflect current market conditions.
As with any tax position, best practice would be to document the rationale for the allocated salary (e.g. market data or a file note), to evidence reasonable consideration and care has been taken.